Charting the Fed’s Record on Inflation: A Big Gap

Ever since the Fed announced an explicit 2% inflation target, actual inflation has fallen short. This chart shows the widening gap.

The Federal Reserve since January 2012 has said it is targeting 2% inflation. How has it done? Not so well, as shown in the chart.

In the 20 years before the Fed said it was targeting inflation, it did a great job: On average, inflation was exactly 2% from 1992 to 2012. Since 2012, inflation has consistently fallen short of the Fed’s target and today stands a full 3.6% below the path for the U.S. PCE index that would be consistent with 2% inflation, indicated by the blue line. (The Fed prefers to monitor personal consumption expenditures, or PCE, while the press reports on the U.S. Consumer Price Index.)

Why does this matter? It helps to account for the Fed’s focus on a “gradual” pace of normalizing interest rates.

With a very gradual path for normalization, the Fed would like not only for inflation to rise back to 2%, but also several Fed officials have said they would like to run the economy at least a little “hot,” which is Fed-speak for allowing inflation to overshoot the 2% target.

As the chart shows, if the Fed wanted to make up for its inflation undershoots since 2012, it would have to engineer and tolerate inflation of at least 3% for three years. Will the Fed go that far? Likely not.

But so long as the pattern in the chart holds, the Fed will be wary of hiking too fast while inflation expectations continue to fall short of the 2% target.  

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