In a significant move reflecting changing economic landscapes, the Federal Open Market Committee (FOMC) recently revised its approach to monetary policy, stepping away from the Flexible Average Inflation Targeting (FAIT) framework it adopted in August 2020. This shift has sparked discussions among economists and policymakers about the implications for inflation control and employment levels in the wake of the COVID-19 pandemic.
The FOMC first introduced its Statement on Longer-Run Goals and Monetary Policy Strategy in January 2012. This initial framework aimed to address deviations of inflation from its 2 percent target, while also focusing on maximizing employment. However, the 2020 revision marked a pivotal change, as the committee embraced FAIT, which allowed for a moderate overshoot of the inflation target following periods of low inflation. The objective was clear: to spur economic growth by mitigating employment shortfalls rather than merely deviations.
Fast forward to August 2025, and the FOMC pivoted again, abandoning FAIT in favor of a more traditional Flexible Inflation Targeting (FIT) approach. This transition signifies a return to the FOMC’s original 2012 goals, with a renewed emphasis on maintaining the 2 percent inflation target and a more straightforward focus on maximizing employment. This change comes at a time when the economic landscape is markedly different from the low-growth environment that characterized the previous decade.
In their recent paper titled “Alternative Policy Rules and Post-Covid Fed Policies,” economists David Papell and Ruxandra Prodan-Boul analyze the efficacy of these policy shifts. They scrutinize Fed policies from the third quarter of 2020 through the fourth quarter of 2027, comparing actual federal funds rate (FFR) data with projections based on various policy rules. The researchers assert that FAIT proved largely irrelevant, with shortfalls in employment being less impactful than initially anticipated.
The 2020 Statement was developed during a period marked by an economic stagnation characterized by low growth, low inflation, and persistently low interest rates. In contrast, the recent economic climate is fraught with uncertainty, making it unlikely that the pre-pandemic economic conditions will return. The FOMC’s decision to substitute FAIT with FIT and diminish the focus on employment shortfalls indicates a willingness to adapt to these evolving economic realities.
The foundation of this policy analysis relies on established economic models, particularly those introduced by economist John Taylor in 1993. Taylor’s rules have been a cornerstone for examining Federal Reserve policy, helping to shape responses based on inflation rates and unemployment gaps. The balanced approach rule, as outlined by Taylor and later expanded by Janet Yellen, incorporates an unemployment gap, emphasizing the importance of employment levels in monetary policy decisions.
In this context, the researchers explore different variants of these rules, including those that prioritize shortfalls in employment over simple deviations. By focusing only on unemployment exceeding longer-run levels, the FFR prescriptions align closely with those set by the balanced approach rule, advocating a more nuanced response to labor market conditions.
The researchers also examined inertial policy rules that adjust the FFR based on previous levels of the rate, which can help stabilize monetary policy responses to economic fluctuations. Their findings suggest that prescriptions based on these inertial rules tend to produce less volatility in the FFR, therefore potentially leading to more stable economic outcomes.
Throughout the analysis, Papell and Prodan-Boul note that the FFR has not consistently aligned with policy prescriptions, particularly in the years following the pandemic. The data indicate that while the prescribed FFR was often higher than the actual FFR in 2021 and 2022, the gap narrowed in subsequent years. By 2025, the predicted FFR and the actual rate are expected to converge, reflecting the ongoing adjustments in the monetary policy landscape.
As the FOMC transitions back to a more traditional stance with the FIT framework, questions arise regarding the effectiveness of this approach in fostering sustainable economic growth and maintaining stable inflation. The discussions surrounding the implications of this policy shift underscore the critical need for adaptive economic strategies in a post-pandemic world.
In conclusion, the Federal Reserve’s recent decision to abandon FAIT for FIT represents a significant recalibration of its monetary policy framework. As economists and policymakers continue to navigate the complexities of the current economic environment, understanding these shifts will be crucial for ensuring a balanced approach that prioritizes both inflation stability and maximum employment. The ongoing research and analysis of these policy changes will play an essential role in shaping the future of monetary policy in the United States.
