overshooting

Try overshooting for two years by Ryan Avent

THIS afternoon, Janet Yellen will release her first Federal Open Market Committee statement as chair and give her first post-meeting press conference. Conventional wisdom is that tapering will continue at its recent pace, and that the FOMC will clarify its forward guidance. It almost certainly won't be announcing a plan to tolerate above-target inflation in order to accelerate the recovery, despite the wisdom of that course.
...
It's a good post. I certainly agree that the mood of the Fed is not what one would call favourably disposed toward some overshooting. FOMC members came of age in the 1970s; as far as most of them are concerned it is never a bad time to trade off a little more unemployment for a little less inflation. Markets certainly don't expect any overshooting. 

But I don't think it is as completely off the table as Mr Duy suggests, for a few reasons. First, policy statements are there to be changed, particularly when the facts justify a switch. At the time the 2% target was set, the median FOMC member projected that the fed funds rate would be 0.75% by the end of this year. Markets now anticipate rates reaching that level in 2016. The longer the Fed maintains its anachronistic policy position, the longer the American economy remains stuck against the zero lower bound. At some point, someone at the Fed may notice this. 

Second, while hopes for a more ambitious policy agenda from Ms Yellen have diminished, it is still the case that there is no time for a regime change like a regime change. It's Ms Yellen's Fed now, and her committee may arrive at a different judgment than Mr Bernanke's. It almost certainly won't, but it could. 

Third, there is actually a lot of wiggle room around that 2% target. As recent experience has shown: the annual change in the price index for personal consumption expenditures—the magic indicator in the target statement—has been below 2% since April of 2012. Indeed, over the past year inflation has been below 1.2% on average. One might argue that a steadfast commitment to a 2% inflation target demands some overshooting to make up for this long period of underperformance; after all, a central bank that tolerates undershooting of its target but not overshooting is missing its target on average. 

Fourth, it's not clear that the Fed has entirely ruled out something of that nature. On the one hand, statements continue to note that the Fed will take a "balanced approach" as it begins to pull back on accommodation. On the other, it was not long ago seen as significant that the the head of the Fed's monetary affairs division was putting his name to researchdemonstrating the benefits of overshooting. 

Though it would be the right thing to do, I don't expect the Fed to announce a new 3% inflation target or 5% wage growth target, or declare its intention to make up half of the shortfall in nominal output relative to the pre-crisis trend. Though it would be a very good thing to do, I don't expect them to say that, in order to defend the integrity of their 2% inflation target, they intend to make up the shortfall in inflation accumulated over the past two years with an 18-month period of overshooting. But while I don't expect those things, I don't think they are entirely outside the realm of possibility, nor do I think that the Fed tied its hands forever in January of 2012.