Changing how the Fed views inflation

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perfectuncertainty
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Changing how the Fed views inflation

Post by perfectuncertainty »

https://www.cnbc.com/2020/08/24/powell- ... ation.html

What do you expect to come out of this meeting/announcement?
What impact do you expect it to have on the dollar? Interest rates?
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FIREchief
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Re: Changing how the Fed views inflation

Post by FIREchief »

Yikes!!! I guess I had better move ALL of my fixed income to TIPS!

Wait a tick.....I already did! 8-)
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occambogle
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Re: Changing how the Fed views inflation

Post by occambogle »

Could someone kindly explain what all this means in real terms to future interest rates (especially LTT), equities, the dollar? I read the article but I don’t really understand the implications...
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Re: Changing how the Fed views inflation

Post by Robot Monster »

perfectuncertainty wrote: Mon Aug 24, 2020 4:47 pm https://www.cnbc.com/2020/08/24/powell- ... ation.html

What do you expect to come out of this meeting/announcement?
What impact do you expect it to have on the dollar? Interest rates?
I expect Powell will announce "2%-average inflation” targeting. This means interest rates are more likely to stay in the gutter for longer. If inflation bubbles up 2.5%, the Fed hawks will not necessarily be taking flight and raising rates (that is, if inflation had previously been trapped at 1.5%). With unemployment what it is, and the specter of Japanification haunting the Fed, it just might be a mighty long time, yes, a mighty long time indeed, before we see those rates rising. Still, bound to happen, one day. A dusty black Cadillac will pull into town. A man wearing a fedora hat will step out. He'll seem rather familiar somehow, and yet no one will be able to say quite who he is. He'll order a Whiskey Sour at the local saloon, and give the bartender a strange kind of smile.
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Re: Changing how the Fed views inflation

Post by cos »

occambogle wrote: Mon Aug 24, 2020 5:26 pm Could someone kindly explain what all this means in real terms to future interest rates (especially LTT), equities, the dollar? I read the article but I don’t really understand the implications...
Considering the market really only responds to unexpected changes in inflation, I would guess that this doesn't mean much.
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perfectuncertainty
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Re: Changing how the Fed views inflation

Post by perfectuncertainty »

Robot Monster wrote: Mon Aug 24, 2020 5:33 pm
perfectuncertainty wrote: Mon Aug 24, 2020 4:47 pm https://www.cnbc.com/2020/08/24/powell- ... ation.html

What do you expect to come out of this meeting/announcement?
What impact do you expect it to have on the dollar? Interest rates?
I expect Powell will announce "2%-average inflation” targeting. This means interest rates are more likely to stay in the gutter for longer. If inflation bubbles up 2.5%, the Fed hawks will not necessarily be taking flight and raising rates (that is, if inflation had previously been trapped at 1.5%). With unemployment what it is, and the specter of Japanification haunting the Fed, it just might be a mighty long time, yes, a mighty long time indeed, before we see those rates rising. Still, bound to happen, one day. A dusty black Cadillac will pull into town. A man wearing a fedora hat will step out. He'll seem rather familiar somehow, and yet no one will be able to say quite who he is. He'll order a Whiskey Sour at the local saloon, and give the bartender a strange kind of smile.
That is my read too - they will keep rates low even if inflation rises (a course shift). It would seem to follow that if inflation is rising (or not) and rates remain low that the dollar will be under pressure, that is if the rest of the world isn't in a similar boat.
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Re: Changing how the Fed views inflation

Post by Seasonal »

The Fed has long had an inflation target of 2%. In practice this has meant they would tolerate inflation below 2%, but not above 2%. The article says they will continue to have a 2% target, but will allow inflation to exceed 2% so long as, on average, it's 2%.

The Fed targets a slightly different version of inflation than the commonly used CPI and smooths inflation by ignoring food and energy, because those tend to be very volatile. Over time, ignoring them has no effect. https://www.federalreserve.gov/econres/ ... 190802.htm

How will this affect interest rates? There are many factors other than inflation which affect interest rates, which is a long way of saying no one knows. The market tends to react to what it believes the Fed will do, rather than any mechanical relation between actual actions and market reaction, which makes it even harder to know what this will do to rates.
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Re: Changing how the Fed views inflation

Post by Skiandswim »

Brookings provided an overview of the Federal Reserves 2% inflation target with a discussion on a move to "average inflation targeting" back in 2019
https://www.brookings.edu/blog/up-front ... targeting/

Australia appears to use a similar policy (or more of a range 2-3% of inflation ), but few other countries. Not sure if there are empirical examples of this policy in action. My take - rates stay lower even if inflation increases above target of 2%. I am just starting to read some of articles on Australia's experience.
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Re: Changing how the Fed views inflation

Post by Robot Monster »

Skiandswim wrote: Mon Aug 24, 2020 6:12 pm Brookings provided an overview of the Federal Reserves 2% inflation target with a discussion on a move to "average inflation targeting" back in 2019
https://www.brookings.edu/blog/up-front ... targeting/

Australia appears to use a similar policy (or more of a range 2-3% of inflation ), but few other countries. Not sure if there are empirical examples of this policy in action. My take - rates stay lower even if inflation increases above target of 2%. I am just starting to read some of articles on Australia's experience.
I invested in TIPS because I'm afraid of a change in Fed target. You say Australia has a 2-3% target; would it shock anyone if the Fed changed to something like that? The Fed changing its inflation target was something raised by the May 7th, 2020 Bloomberg article, "Inflation Is the Way to Pay Off Coronavirus Debt":

"...But there’s another way that the government can shrink the mountain of debt weighing down the U.S. economy: inflation. Because most interest payments are fixed in nominal terms, inflation makes existing debt less important in real terms. Raising the long-term inflation target from the current 2% to a still-modest 4% would substantially increase the rate at which debt effectively vanishes...."
https://www.bloomberg.com/opinion/artic ... virus-debt
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Re: Changing how the Fed views inflation

Post by 000 »

Robot Monster wrote: Mon Aug 24, 2020 8:05 pm I invested in TIPS because I'm afraid of a change in Fed target.

"Inflation Is the Way to Pay Off Coronavirus Debt":
Hiring the fox to guard the henhouse :twisted:
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Re: Changing how the Fed views inflation

Post by Random Musings »

Higher inflation and still low interest rates? You would think rational markets would want higher yields so that real returns don't tank. If they somehow force yields to stay low, then won't the average standard of living go down?

Perhaps equities will shoot to the moon to compensate.

RM
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Re: Changing how the Fed views inflation

Post by Impatience »

All the more reason to stay 100% in equities and keep absolutely as little in cash as I possibly can.
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Re: Changing how the Fed views inflation

Post by 000 »

Impatience wrote: Mon Aug 24, 2020 9:15 pm All the more reason to stay 100% in equities and keep absolutely as little in cash as I possibly can.
I am thinking about reducing cash to bare minimum and go 100% Stocks/REITs/Gold.
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Re: Changing how the Fed views inflation

Post by Alchemist »

perfectuncertainty wrote: Mon Aug 24, 2020 4:47 pm https://www.cnbc.com/2020/08/24/powell- ... ation.html

What do you expect to come out of this meeting/announcement?
What impact do you expect it to have on the dollar? Interest rates?
Overall this is an evolution of Fed policy toward something more explicitly pure Keynesian or dare I say MMT-lite-ish.

Ultimately this gives Congress much more room to implement stimulus spending. In the short term this means if the new Congress/President in 2021 is friendly to higher long term deficits to spur economic recovery, the Fed will not slam on the brake via interest rates based on anticipation of inflation and instead will do the far more rational thing of waiting until signs of inflation actually arrive before trying to tamp it down.

Think of this as the opposite of what happened in 2018. The Congress passed stimulative policy (in that case, tax cuts) that increased deficit spending. Anticipating higher inflation, the Fed raised rates and put any stop to expansion based on the new stimulus.

This is a self-defeating arrangement. If the Fed instead will be re-active instead of pro-active on inflation, it gives room for deficit based stimulus to actually be stimulative. Inflation lets you know when your deficit gets too big (and deflation lets you know when its too small), not interest rates.

Robot Monster wrote: Mon Aug 24, 2020 8:05 pm
I invested in TIPS because I'm afraid of a change in Fed target. You say Australia has a 2-3% target; would it shock anyone if the Fed changed to something like that? The Fed changing its inflation target was something raised by the May 7th, 2020 Bloomberg article, "Inflation Is the Way to Pay Off Coronavirus Debt":

"...But there’s another way that the government can shrink the mountain of debt weighing down the U.S. economy: inflation. Because most interest payments are fixed in nominal terms, inflation makes existing debt less important in real terms. Raising the long-term inflation target from the current 2% to a still-modest 4% would substantially increase the rate at which debt effectively vanishes...."
https://www.bloomberg.com/opinion/artic ... virus-debt
Eh, "national debt" doesn't matter to a currency sovereign like the United States. Treasuries are just interest-bearing dollars. The Fed or the Mint could erase 50% of the national debt tomorrow with key strokes or the minting of a $10 Trillion coin. It would not matter because the money was already created and sent into the economy when the deficit spending occurred and the treasuries were created.

If more people and policy makers understood the difference between the budget of a currency user and a currency issuer, we could have much more productive discussions about debt and inflation.

Actionability for a Boglehead: Don't do something, just stand there. Never, ever, ever fight the Fed.
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Re: Changing how the Fed views inflation

Post by 000 »

Alchemist wrote: Mon Aug 24, 2020 9:23 pm Eh, "national debt" doesn't matter to a currency sovereign like the United States. Treasuries are just interest-bearing dollars. The Fed or the Mint could erase 50% of the national debt tomorrow with key strokes or the minting of a $10 Trillion coin. It would not matter because the money was already created and sent into the economy when the deficit spending occurred and the treasuries were created.
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Re: Changing how the Fed views inflation

Post by scout1 »

The Financial Times reported on the likelihood of this happening on February 9th of this year.

https://www.ft.com/content/c0a1fddc-467 ... 5839e06441

Scott Sumner addressed it in his blog as well. Basically this is a good thing as the Fed is finally figuring out how to use monetary policy more effectively. In fact, we saw that occur over the last few months with COVID-19. GDP absolutely collapsed, unemployment skyrocketed and the country is still chugging along.

Please note, this is not an MMT issue which you have heard so much about. MMT is primarily related to fiscal policy, while this is monetary policy.
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Re: Changing how the Fed views inflation

Post by TaxingAccount »

Who is going to buy 30 year treasuries with a 1.3% yield when inflation is 10%? thanks
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Re: Changing how the Fed views inflation

Post by Forester »

000 wrote: Mon Aug 24, 2020 8:11 pm
Robot Monster wrote: Mon Aug 24, 2020 8:05 pm I invested in TIPS because I'm afraid of a change in Fed target.

"Inflation Is the Way to Pay Off Coronavirus Debt":
Hiring the fox to guard the henhouse :twisted:
TIPs investors are setting themselves up for disappointment, the open question is by how much.
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Re: Changing how the Fed views inflation

Post by Robot Monster »

Alchemist wrote: Mon Aug 24, 2020 9:23 pm Eh, "national debt" doesn't matter to a currency sovereign like the United States. Treasuries are just interest-bearing dollars. The Fed or the Mint could erase 50% of the national debt tomorrow with key strokes or the minting of a $10 Trillion coin. It would not matter because the money was already created and sent into the economy when the deficit spending occurred and the treasuries were created.

If more people and policy makers understood the difference between the budget of a currency user and a currency issuer, we could have much more productive discussions about debt and inflation.


Actionability for a Boglehead: Don't do something, just stand there. Never, ever, ever fight the Fed.
Eh, "national debt" is quite the introduction. If the Fed, or Mint, can just erase 50% of the thing with such ease, by golly, why don't they? And, sorry, but what's holding them back at a mere 50%? Such small potatoes.

In all seriousness, I have to admit I don't understand much (bolded above) of what you're saying. Also, I've heard "don't fight the Fed" before, but don't understand how one would go about doing that.
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Re: Changing how the Fed views inflation

Post by Robot Monster »

Forester wrote: Tue Aug 25, 2020 3:08 am
000 wrote: Mon Aug 24, 2020 8:11 pm
Robot Monster wrote: Mon Aug 24, 2020 8:05 pm I invested in TIPS because I'm afraid of a change in Fed target.

"Inflation Is the Way to Pay Off Coronavirus Debt":
Hiring the fox to guard the henhouse :twisted:
TIPs investors are setting themselves up for disappointment, the open question is by how much.
Disappointment? That depends on what TIPS investors' expectations are.
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Re: Changing how the Fed views inflation

Post by atdharris »

I wonder if it's time to reduce my LTT holdings... right now that's my hedge against a market drop. But I know it will get killed if inflation ramps up
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Re: Changing how the Fed views inflation

Post by Seasonal »

Robot Monster wrote: Tue Aug 25, 2020 8:59 am
Alchemist wrote: Mon Aug 24, 2020 9:23 pm Eh, "national debt" doesn't matter to a currency sovereign like the United States. Treasuries are just interest-bearing dollars. The Fed or the Mint could erase 50% of the national debt tomorrow with key strokes or the minting of a $10 Trillion coin. It would not matter because the money was already created and sent into the economy when the deficit spending occurred and the treasuries were created.

If more people and policy makers understood the difference between the budget of a currency user and a currency issuer, we could have much more productive discussions about debt and inflation.


Actionability for a Boglehead: Don't do something, just stand there. Never, ever, ever fight the Fed.
Eh, "national debt" is quite the introduction. If the Fed, or Mint, can just erase 50% of the thing with such ease, by golly, why don't they? And, sorry, but what's holding them back at a mere 50%? Such small potatoes.

In all seriousness, I have to admit I don't understand much (bolded above) of what you're saying. Also, I've heard "don't fight the Fed" before, but don't understand how one would go about doing that.
The bolded part is a standard modern monetary theory, aka MMT, statement - you and I (who use currency) and different from the government (which issues currency) and analogizing from a household budget to a govt budget is misleading. This is a restatement of the usual economics statements that a household budget is fundamentally different from a government budget and that a government that issues debt in its own currency cannot default (other than voluntarily) - it can just issue new money to pay the debt.

The supposed danger of too much debt is too much inflation, and inflation is far from a problem today. Why would the Fed do something politically risky for no benefit? A major danger of too much debt is that it can serve as a constraint on the govt doing worthwhile things, due to widespread fears of debt.
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Re: Changing how the Fed views inflation

Post by Robot Monster »

Seasonal wrote: Tue Aug 25, 2020 9:15 am
Robot Monster wrote: Tue Aug 25, 2020 8:59 am
Alchemist wrote: Mon Aug 24, 2020 9:23 pm Eh, "national debt" doesn't matter to a currency sovereign like the United States. Treasuries are just interest-bearing dollars. The Fed or the Mint could erase 50% of the national debt tomorrow with key strokes or the minting of a $10 Trillion coin. It would not matter because the money was already created and sent into the economy when the deficit spending occurred and the treasuries were created.

If more people and policy makers understood the difference between the budget of a currency user and a currency issuer, we could have much more productive discussions about debt and inflation.


Actionability for a Boglehead: Don't do something, just stand there. Never, ever, ever fight the Fed.
Eh, "national debt" is quite the introduction. If the Fed, or Mint, can just erase 50% of the thing with such ease, by golly, why don't they? And, sorry, but what's holding them back at a mere 50%? Such small potatoes.

In all seriousness, I have to admit I don't understand much (bolded above) of what you're saying. Also, I've heard "don't fight the Fed" before, but don't understand how one would go about doing that.
The bolded part is a standard modern monetary theory, aka MMT, statement - you and I (who use currency) and different from the government (which issues currency) and analogizing from a household budget to a govt budget is misleading. This is a restatement of the usual economics statements that a household budget is fundamentally different from a government budget and that a government that issues debt in its own currency cannot default (other than voluntarily) - it can just issue new money to pay the debt.

The supposed danger of too much debt is too much inflation, and inflation is far from a problem today. Why would the Fed do something politically risky for no benefit? A major danger of too much debt is that it can serve as a constraint on the govt doing worthwhile things, due to widespread fears of debt.
I appreciate the explanation. If the government printed money to pay off debt, what would the possible ramifications be? Increased inflation? Trying to understand if it's possible to hedge against the government doing this, i.e. how this is actionable.
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Re: Changing how the Fed views inflation

Post by Seasonal »

Robot Monster wrote: Tue Aug 25, 2020 9:31 am I appreciate the explanation. If the government printed money to pay off debt, what would the possible ramifications be? Increased inflation? Trying to understand if it's possible to hedge against the government doing this, i.e. how this is actionable.
Unknown. The answer would likely depend on the magnitude of the payment and what was going on in the rest of the economy.

The market likely cares about the things you do, including inflation. Current pricing and rates reflect these concerns.

TIPS protect against inflation. Hedging however implies something that protects the rest of your portfolio rather than just a single type of investment being insulated against the concern. I don't believe there exists an accessible hedge of this type.
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Re: Changing how the Fed views inflation

Post by Ketawa »

To my understanding (not an economist at all), if this was implemented, it would be a move towards a "level targeting" policy. If the Fed has a 2% inflation target, but misses it and inflation is 1% instead, then one possible implementation of level targeting is that it could attempt to target 3% inflation for the next year. People bemoaning this are ignoring that it works in both directions; if realized inflation is too high, the Fed will target lower inflation in the future.

The benefits of this are, for example, that failing to hit the 1% inflation target means that Fed policy was too tight in the past by the Fed's own standards. That has short-run effects that need to be made up with more expansionary policy. It can mean smoother business cycles over the long run, quicker recovery from recessions, etc. Proponents of this approach would favor nominal GDP level targeting (NGDPLT) as a best solution; inflation level targeting would be a step in the right direction.

The Fed only has substantial control over the federal funds rate. Market forces are far more important for the rest of the yield curve, and the Fed has plenty of ways to perform stimulus even at the zero lower bound.

Moving to a level targeting policy would be an improvement in the ability of the Fed to set expectations and meet them, which is one primary goal of monetary policy.
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Re: Changing how the Fed views inflation

Post by cheezit »

I don't understand why the financial media is treating this as a bombshell, or even news. The Fed has been calling 2% a "symmetric" target since at least January of 2017, 3 and a half years ago, and has elaborated on this repeatedly. To wit, here's the executive summary of the speech that Charles Evans, President and CEO of the Federal Reserve Bank of Chicago, gave at a summit in November 2017:
  • Real activity in the U.S. is solid, but inflation is—and has been for quite some time—too low.
  • I am concerned that persistent factors are holding down inflation, rather than idiosyncratic transitory ones. Namely, the public’s inflation expectations appear to me to have drifted down below the Federal Open Market Committee’s (FOMC) 2 percent symmetric inflation target.
  • In order to dispel any impression that 2 percent is a ceiling, our communications should be much clearer about our willingness to deliver on a symmetric inflation outcome, acknowledging a greater chance of inflation at 2-1/2 percent in the future than what has been communicated in the past.
  • Such communications would shore up our credibility and demonstrate our commitment. They would also increase policymakers’ ability to attain their goals in normal times and to strengthen the policy framework to deal with future challenges presented by unexpected economic and financial developments.
(my emphasis added)



Also, scanning the Chicago Fed's website, I found something that may only be of interest to nisiprius: a description of the Fed's "Dual Mandate" that references the 1977 revisions to the Federal Reserve Act's actual textual triple mandate
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Re: Changing how the Fed views inflation

Post by Robot Monster »

Seasonal wrote: Tue Aug 25, 2020 9:43 am
Robot Monster wrote: Tue Aug 25, 2020 9:31 am I appreciate the explanation. If the government printed money to pay off debt, what would the possible ramifications be? Increased inflation? Trying to understand if it's possible to hedge against the government doing this, i.e. how this is actionable.
Unknown. The answer would likely depend on the magnitude of the payment and what was going on in the rest of the economy.

The market likely cares about the things you do, including inflation. Current pricing and rates reflect these concerns.

TIPS protect against inflation. Hedging however implies something that protects the rest of your portfolio rather than just a single type of investment being insulated against the concern. I don't believe there exists an accessible hedge of this type.
Unknown, but possible, in the way balancing a tall glass of water on one's head may result in a nasty spill? If one wants to decrease their risk against such a scenario, seems TIPS is a possible route? (I understand it's not going to protect the rest of one's portfolio.)
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Re: Changing how the Fed views inflation

Post by Seasonal »

ketawa, if you're not reading Scott Sumner, you should https://www.themoneyillusion.com/

cheezit, the Fed has said that, but their actions have led many to believe they didn't really mean it. It's their actions that have created the "impression that 2 percent is a ceiling".

Robot Monster: No. Unknown as in it really depends. TIPS are designed to protect against unexpected inflation. If you're worried about inflation, consider TIPS. There's lots of info here.
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Re: Changing how the Fed views inflation

Post by Ketawa »

Seasonal wrote: Tue Aug 25, 2020 10:05 am ketawa, if you're not reading Scott Sumner, you should https://www.themoneyillusion.com/
I do.
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Re: Changing how the Fed views inflation

Post by Angst »

cheezit wrote: Tue Aug 25, 2020 9:58 am I don't understand why the financial media is treating this as a bombshell, or even news. The Fed has been calling 2% a "symmetric" target since at least January of 2017, 3 and a half years ago, and has elaborated on this repeatedly. To wit, here's the executive summary of the speech that Charles Evans, President and CEO of the Federal Reserve Bank of Chicago, gave at a summit in November 2017:
  • Real activity in the U.S. is solid, but inflation is—and has been for quite some time—too low.
  • I am concerned that persistent factors are holding down inflation, rather than idiosyncratic transitory ones. Namely, the public’s inflation expectations appear to me to have drifted down below the Federal Open Market Committee’s (FOMC) 2 percent symmetric inflation target.
  • In order to dispel any impression that 2 percent is a ceiling, our communications should be much clearer about our willingness to deliver on a symmetric inflation outcome, acknowledging a greater chance of inflation at 2-1/2 percent in the future than what has been communicated in the past.
  • Such communications would shore up our credibility and demonstrate our commitment. They would also increase policymakers’ ability to attain their goals in normal times and to strengthen the policy framework to deal with future challenges presented by unexpected economic and financial developments.
(my emphasis added)

I pretty much agree with cheezit here. To regular Fed watchers, this ought to be a big yawn.

Fed officials, including Powell himself, have been openly discussing moving to "inflation averaging" for maybe a year or so now, and back in (I think) January, there was a Fed announcement about this continuing to be considered and the expectation that the Fed would be addressing it specifically at some point in the near future. I remember I even commented on it at the time in the forum.

The media and some Fed followers do seem to enjoy trying to read between the lines when it comes to anything announced by the Fed. Perhaps this is a legacy of Greenspan's style? Regardless, I think this policy "adjustment" or "clarification" is reasonable and appropriate and probably would have been so if it had been included in the first place, decades ago when 2% inflation targeting policy originally came about.
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Re: Changing how the Fed views inflation

Post by FIREchief »

Robot Monster wrote: Tue Aug 25, 2020 9:05 am
Forester wrote: Tue Aug 25, 2020 3:08 am
000 wrote: Mon Aug 24, 2020 8:11 pm
Robot Monster wrote: Mon Aug 24, 2020 8:05 pm I invested in TIPS because I'm afraid of a change in Fed target.

"Inflation Is the Way to Pay Off Coronavirus Debt":
Hiring the fox to guard the henhouse :twisted:
TIPs investors are setting themselves up for disappointment, the open question is by how much.
Disappointment? That depends on what TIPS investors' expectations are.
Bingo!! :sharebeer They do exactly what I expect them to do. How could I wind up "disappoined?" The outcomes with TIPS are much more certain than with nominal bonds. It's more likely that the nominal bond buyer might be setting themselves up for disappointment.
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Re: Changing how the Fed views inflation

Post by Robot Monster »

Angst wrote: Tue Aug 25, 2020 11:22 am ...decades ago when 2% inflation targeting policy originally came about.
I thought that 2% target was a recent invention...ah, seems I was wrong:
"In 1996, Fed policymakers privately agreed that their target for inflation was 2 percent, but, at Greenspan’s insistence, they didn’t tell anyone. In 2012, at the urging of then-Chair Ben Bernanke, the Fed formally and publicly announced that they were targeting a 2 percent inflation rate."
https://www.brookings.edu/research/alte ... on-target/
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Re: Changing how the Fed views inflation

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  • conspiracy theories of any type
  • discussions of the crimes, shortcomings or stupidity of other people, whether they be political figures, celebrities, CEOs, Fed chairmen, subprime mortgage borrowers, lottery winners, federal "bailout" recipients, poor people, rich people, etc. Of course, you are welcome to talk about the stupid financial things you have done.
"I’ve come around to this: If you’re dumb, surround yourself with smart people; and if you’re smart, surround yourself with smart people who disagree with you." (Aaron Sorkin)
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