A "Rethinking" at the Federal Reserve

Samuel Rines

Economics, Americas

The Federal Reserve has decided to "rethink" its current monetary policy approach. What does this mean for the United States?

Since the Federal Reserve decided to undergo a “rethinking” of its monetary policy target and communication, there have been numerous suggestions about what this new framework should look like. These have ranged from an “average inflation target” to “nominal GDP targeting” to “yield curve targeting.” While all different, these tend to be more dovish than the current framework. This means interest rates would be held lower for longer or more unconventional policy measures would be taken to achieve the target. This has generally led to the assumption that the Fed will have a more dovish framework coming out of this rethink. But that may not be the case.

To begin, the Fed does not use the consumer price index (CPI) for forecasting or generally looking at inflation pressures. And, because it is not used by the Fed, it is not going to be discussed here. The Fed's preferred gauge is the core (ex-food and energy) personal consumption expenditures (PCE) price index, because it is a better measure for understanding of underlying inflation pressures than its CPI relative. But it is far from perfect. It is volatile and susceptible to “outlier” readings on individual lines moving the index one way or the other. this renders it a difficult mechanism to use in setting monetary policy.

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