Did the Federal Reserve Anchor Inflation Expectations Too Low?
Abstract: In 2012, the Federal Reserve adopted a 2 percent target for inflation to firmly anchor longer-term inflation expectations. Since then, inflation has averaged about 1.4 percent. Modern theories suggest that inflation should eventually gravitate toward measures of longer-run inflation expectations. The tendency for inflation to reside below the Federal Reserve’s 2 percent inflation target over much of the past decade raises questions of whether longer-run inflation expectations are anchored—and, if so, whether they are anchored below 2 percent. Brent Bundick and A. Lee Smith argue that the Federal Reserve’s communication of a numerical objective for inflation better anchored longer-term inflation expectations; however, Federal Open Market Committee (FOMC) projections for longer-run inflation from 2009–11 may have anchored them below 2 percent. The authors present evidence that the 2009 addition of longer-run inflation to the FOMC’s Summary of Economic Projections (SEP), together with the eventual adoption of a longer-run 2 percent inflation objective in 2012, made investors’ inflation expectations more stable. At the same time, SEP projections for longer-run inflation from 2009 to 2011 generally resided below 2 percent, which may have led inflation expectations to anchor below 2 percent.
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Provider: Federal Reserve Bank of Kansas City
Part of Series: Economic Review
Publication Date: 2021-03-04