June 07, 2023

Forty years ago, the biggest problem our economy faced was high and rising inflation. The Great Inflation demanded a clear focus on restoring the credibility of the FOMC's commitment to price stability. Chair Paul Volcker brought that focus to bear, and the "Volcker disinflation," with the continuing stewardship of Alan Greenspan, led to the stabilization of inflation and inflation expectations in the 1990s at around 2 percent. The monetary policies of the Volcker era laid the foundation for the long period of economic stability known as the Great Moderation. …….We have also made important changes with regard to the price-stability side of our mandate. Our longer-run goal continues to be an inflation rate of 2 percent. Our statement emphasizes that our actions to achieve both sides of our dual mandate will be most effective if longer-term inflation expectations remain well anchored at 2 percent. However, if inflation runs below 2 percent following economic downturns but never moves above 2 percent even when the economy is strong, then, over time, inflation will average less than 2 percent. Households and businesses will come to expect this result, meaning that inflation expectations would tend to move below our inflation goal and pull realized inflation down. To prevent this outcome and the adverse dynamics that could ensue, our new statement indicates that we will seek to achieve inflation that averages 2 percent over time. Therefore, following periods when inflation has been running below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time. In seeking to achieve inflation that averages 2 percent over time, we are not tying ourselves to a particular mathematical formula that defines the average. Thus, our approach could be viewed as a flexible form of average inflation targeting.26 Our decisions about appropriate monetary policy will continue to reflect a broad array of considerations and will not be dictated by any formula. Of course, if excessive inflationary pressures were to build or inflation expectations were to ratchet above levels consistent with our goal, we would not hesitate to act. It seems that the smooth market functioning does not include the US inflation rate, which the Fed claimed initially as transitory and has had a difficult time stamping out for fear of messing up some of the other policy objectives that it now attributes to itself. Judging from what happened to the inflation rate, we must conclude that either the Fed did not learn its lesson or perhaps during COVID it had other overriding concerns that took priority over the inflation rate. Either way the Fed failed in its implementation of monetary policy or expanded its portfolio to pursue other objectives. No matter how we slice it, the Fed appears to have lost its Volker Rule compass.

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