M-RCBG Associate Working Paper No. 163

The Fed's Monetary Policy Framework in the wake of COVID-19: New Framework Elements, and ad hoc Fiscal-Monetary Coordination

Jeff Fuhrer



In the fall of 2018, the Fed embarked on a process to conduct a systematic review of its monetary policy framework (MPF). Initiated by Chair Powell and headed up by Vice-Chair Clarida, the process was meant to evaluate the current MPF—the tools, strategies and communications by which the Fed aims to achieve its Congressionally-mandated goals—and consider whether any systematic changes might be beneficial.

The review was prompted by the joint challenges of

• Low equilibrium interest rates, which imply more frequent trips to the effective lower bound;
• Inflation that has been chronically below the Fed’s two percent objective;
• A slip in long-run inflation expectations, likely related to the prolonged history of below-2% inflation;
• A very low response of inflation to economic activity (a “flat Phillips curve”) that in turn implies a low response of inflation to monetary policy actions; and
• A concern that these environmental challenges jointly put both inflation and unemployment goals at risk going forward.

The central question of the review was whether alternative policies such as “make-up” policies—loosely, policies that try to achieve an inflation rate that averages two percent, rather than just attain two percent without regard to inflation’s history above or below two—could help the Fed to effectively stabilize the economy, keeping it closer to full employment, and centering inflation more consistently on the 2% objective. We will discuss the theoretical and practical appeal of such policies in more detail below.

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