Not So Fast


  • Headline U.S. inflation as measured by personal consumption expenditures (PCE) rose 2.1% year-over-year in February 2017, finally exceeding the Fed’s 2% inflation target. But it’s probably not cause for great celebration. Core inflation remains below target, for one thing, and headline may drop again soon unless oil prices climb steeply.
  • The Fed recently emphasized that its inflation target is “symmetric,” meaning a certain level of overshoots and undershoots are equally tolerated and there is no promise to correct deviations once they have occurred.
  • To achieve a 2% average inflation target over time, the Fed may have to temporarily aim at above 2% inflation in “normal” times – that is, when the policy rate is not at the effective lower bound.
  • Will the Fed overshoot 2% inflation as long as the fed funds rate is not at the lower bound? Perhaps not. For one thing, it is not clear whether the Fed could reliably engineer a significant overshoot even if it wanted to. Also, the current Fed appears to be in opportunistic tightening mode, and a future Fed (with different membership) may not want or be able to overshoot the target.

At last! After spending 57 months below the Federal Reserve’s 2% inflation objective, a key measure of price movements – the headline U.S. index of personal consumption expenditures (PCE) – rose by 2.1% year-over-year in February. In fact, this was only the fourth month PCE inflation exceeded the 2% target since it was announced by then Fed Chairman Ben Bernanke in January 2012 – and the other three times were in 2012!

So, when the inflation data was released, were champagne corks popping in the Federal Reserve Board’s Eccles Building on Constitution Avenue?

Probably not, for three reasons. First, Fed Chair Janet Yellen and her colleagues know that four months above versus 57 months below a symmetric inflation target isn’t exactly a well-balanced economic performance. Second, core PCE inflation, a better gauge of medium-term trends than headline inflation, rose to 1.8% but remains below the target (see Figure 1). And third, headline PCE inflation is likely to fall back below 2% again over the next few months unless oil prices climb at a similarly steep pace as they did from the February 2016 trough. In fact, in the eurozone, the “flash” HICP inflation estimate for March dropped to 1.5% annualized from 2.0% in February, partly due to the base effect in oil prices that will also affect the U.S. Consumer Price Index inflation data for March, due to be released on 14 April.

Many shades of inflation targeting

One year ago, I proposed that the Fed should regain lost ground on inflation by moving to price-level targeting, which would imply compensating for the past cumulative shortfall of price appreciation relative to its objective by aiming to overshoot by a similar cumulative amount in the next several years. I argued that this would help to re-anchor long-term inflation expectations, which had persistently fallen below the target and, despite some increase since the November 2016 U.S. election, have remained sub-par. However, Fed officials have repeatedly rejected price-level targeting, with the latest example provided by (dovish) Chicago Fed President Charles Evans, who said in Madrid on 27 March that the Fed should not try to make up for past deviations from target. Yet, Evans also re-emphasized that the Fed’s inflation objective is symmetric on a forward-looking basis, thus echoing the Federal Open Market Committee (FOMC) statement following its March meeting, where officials inserted the reminder that the inflation goal is “symmetric.”