Have Your Cake and Eat It Too: The Fed’s 2025 Framework

The FOMC's “return to basics” leaves the Fed flexible on paper, but fragile in practice.

The Fed’s framework review is officially over. This past Friday, Fed Chair Jerome Powell announced in a speech that the FOMC is going to replace its Flexible Average Inflation Target (FAIT) framework with a more traditional flexible inflation target (FIT). This shift should come as no surprise. Powell first signaled the change back in November 2024 and subsequent FOMC discussions reinforced that message. The announcement, moreover, merely formalized what was already reality: the effective abandonment of FAIT in early 2022, when the Fed pivoted aggressively to contain surging inflation.

Chair Powell emphasized in his speech that the “revised statement now more closely aligns with the original 2012 language,” while also stressing “a great deal of continuity with past statements,” including nods to the 2020 consensus framework. In effect, the Fed is trying to have it both ways: a “return to basics” with a conventional FIT, yet still keeping the option to deploy its zero lower bound tools in a future crisis. It is a clever balancing act, but one that risks backfiring. The more the Fed presents this framework as both simpler and crisis-ready, the greater the chance that communication becomes muddled and credibility erodes, depending on how and by whom it is put into practice.

As someone who has closely followed the framework review, I have long argued that there is a straightforward way to implement a FIT that both addresses the FOMC’s crisis concerns and is far easier to communicate: anchor the inflation target to a stable growth path for nominal income. This is a well-trodden topic in this newsletter, so I will not belabor the point here. Instead, I want to highlight the potential communication and credibility challenges the new framework creates, which I will outline in the sections that follow.

What is New in the 2025 Fed Framework

The new Fed framework is found in the FOMC’s Longer-Run Goals and Monetary Policy Strategy, better known as the “consensus statement.” In this document the FOMC made three major changes.

First, the FOMC got rid of the effective lower bound (ELB) focus of the 2020 statement and now aspires to have a framework that is robust to “a broad range of economic conditions”:

The Committee's monetary policy strategy is designed to promote maximum employment and stable prices across a broad range of economic conditions…

However, the FOMC cannot completely quit its ELB worries and so commits to the following:

The Committee is prepared to use its full range of tools to achieve its maximum employment and price stability goals, particularly if the federal funds rate is constrained by its effective lower bound

Presumably, the “full range of tools” includes balance sheet policies, which is not mentioned elsewhere in the statement. Does the “full range of tools” also include make-up policy for its inflation target? The FOMC explicitly dropped the make-up policy language in this new framework, but also added that it will “act forcefully to ensure that longer-term inflation expectations remain well anchored.” Using its full range of tools and acting forcefully to anchor inflation expectations suggests that make-up policy is also in the Fed’s toolbox and could be used in emergencies. A second change, then, is that make-up policy went from being at the forefront of the inflation targeting framework to silently lurking in the shadows of its toolbox.

A third change is that the asymmetric “shortfalls” from maximum employment language has been dropped to avoid, as Chair Powell put it, the impression of a “commitment to permanently forswear preemption or to ignore labor market tightness.” However, the FOMC also added that it recognizes “employment may at times run above real-time assessments of maximum employment without necessarily creating risks to price stability.” So while the FOMC has abandoned shortfalls it has not fully returned to a “deviations” from maximum employment approach.

Challenges Created by the New Framework

The changes outlined above leave the Fed in the awkward position of wanting to have its cake and eat it too. On the one hand, it proclaims a robust monetary policy strategy that is meant to withstand a broad range of economic conditions. On the other hand, the Fed cannot let go of its long-standing fear of the ELB, so it keeps the door cracked open for unconventional tools. Similarly, while it officially jettisons the language of make-up policy that once defined FAIT, the references to acting “forcefully” and using the “full range of tools” leave make-up policy lurking in the background as an unspoken option. And finally, although the explicit focus on “shortfalls” from maximum employment is gone, the Fed still allows for employment to run above real-time assessments of maximum employment when conditions permit, effectively hedging on the full symmetry implied by a strict “deviations” approach.

This rhetorical balancing act—compounded by undefined terms such as maximum employment, full range of tools, and act forcefully—may preserve flexibility, but it also invites excessive discretion, confusion, and communication challenges that could undermine the framework’s effectiveness.

To be fair, the framework is the product of a large committee and inevitably reflects compromise. Building consensus among policymakers with different views on inflation risks, labor market dynamics, and financial stability requires ambiguity, and the 2025 framework bears the marks of that process.

Still, that ambiguity comes at a cost. By leaving so much room for interpretation, the framework makes it easy for a future FOMC to reinterpret and reshape monetary policy in ways that may diverge sharply from the current committee’s intent.

For example, in the face of a negative supply shock, such as a disruption to commodity supply that raises prices, the Fed's vague pledge to 'act forcefully' could lead a more hawkish-leaning FOMC to tighten policy too aggressively. Rather than looking through a temporary burst of inflation that monetary policy cannot control, such a committee might treat the rhetoric of forceful action as a license to hike rapidly, sacrificing employment gains and deepening the downturn. History shows the danger of this inflation-myopia: in 2008 the Fed was slow to ease even as the economy unraveled because headline inflation, driven by oil, remained elevated, while the ECB went further astray in 2011 by raising rates into the teeth of the Eurozone crisis. Both episodes reflected a fixation on inflation prints at the expense of broader nominal stability, and both proved costly.

On the other side of the spectrum, a future chair facing fiscal pressures could just as easily invoke the same ambiguous language to justify easier policy. A Trump-appointed chair, for instance, might argue that high interest costs are themselves inflationary and therefore warrant aggressive rate cuts to relieve that pressure. The vague commitment to using the “full range of tools” could likewise be stretched to restart quantitative easing (QE) under the guise of stabilizing a wobbly Treasury market. What begins as flexibility for crisis management could quickly morph into a mandate for fiscal accommodation. In this sense, ambiguity is a double-edged sword: in the wrong hands, it can enable both hawkish overreach and dovish subservience, each carrying risks of its own.

The Irony of the New Framework

There is an irony to this new framework. In the same speech where Chair Powell announced the return to FIT, he also acknowledged that monetary policy finds itself in a quandary:

In the near term, risks to inflation are tilted to the upside, and risks to employment to the downside—a challenging situation. When our goals are in tension like this, our framework calls for us to balance both sides of our dual mandate.

But how exactly is the Fed supposed to strike that balance? It cannot know in real time whether sticky inflation is transitory or where maximum employment truly lies. In moments of such uncertainty, the Fed needs clear guardrails to help guide its decisions. Instead, it has just written itself a framework so pliable that even the most capable central banker could lose their way. It is like asking an airplane pilot to navigate a storm with no instruments and only a vague sense of the destination. Relying solely on instinct and judgment, even the best aviator is bound to veer off course.

Milton Friedman to the Rescue

Enter Milton Friedman. He argued that monetary policy should be guided by simple, transparent rules rather than the shifting judgments of policymakers. Discretion, he warned, leaves central banks vulnerable to political pressure, prone to overreact to short-term developments, and hampered by the fact that policymakers never have perfect real-time information. His simple money growth rule may be outdated, but his deeper insight still holds: in uncertain times, clear and systematic guardrails are essential to keep policy on course.

The Fed could honor that spirit by anchoring its flexible inflation target to a stable growth path for nominal income. That is, the Fed could crosscheck movements in inflation against the forecast of total dollar income growth. If the forecasted growth path was stable, then temporary movements in inflation could be ignored. However, if nominal income was accelerating above a stable growth path, then rising inflation should be taken more seriously and vice versa. The Dallas Fed shows how this could be done in practice.

This approach would provide a simple, clarifying guardrail that revealed whether policy is too tight or too loose without relying on uncertain real-time estimates of maximum employment or decisions about transitory versus persistent inflation. By cross checking its inflation target against the forecasted growth path of total dollar income, the Fed could reduce the risk of repeating past mistakes that come from chasing noisy data. This approach would also allow inflation to rise temporarily in response to negative supply shocks, so long as nominal income remained on a stable growth path. In short, tying the Fed’s FIT to a stable nominal income growth path would directly address the Fed’s information problem while providing the systematic, rule-like clarity Friedman envisioned—yet it would retain the flexibility needed to accommodate shocks beyond the reach of monetary policy.

Fittingly, at the same Jackson Hole meetings where Jerome Powell unveiled the Fed’s new framework, a paper by Emi Nakamura, Venance Riblier, and Jón Steinsson inadvertently made the case for something like a nominal income target. The authors showed that “immaculate disinflation” is possible when policy rules are shock-contingent (i.e., able to see through supply shocks), robust to output gap uncertainty, and anchored in expectations of the nominal economy. In other words, they outlined the very logic behind a nominal income—or NGDP—target. As Pat Horan and I have argued, the beauty of such an approach is that it offers a two-for-one deal: target the growth path of NGDP and you also get an inflation target that is naturally robust to supply shocks. Having the FOMC cross-check its FIT against a stable nominal income path would move policy a long way toward that outcome.

Conclusion

In the end, the Fed’s new framework may look like a return to basics, but its ambiguity risks both overreaction and drift. Friedman’s insight—that rules matter most when uncertainty is highest—remains as relevant as ever. Anchoring policy to a stable growth path for nominal income would not only fulfill the spirit of that insight, but also capture the very features modern research shows are critical for successful disinflation. For a central bank flying blind, a stable nominal income growth path is the compass it has long been missing.