Is the Fate of FAIT Sealed?
Yes. But the spirit of makeup policy endures.
As many of you know, I have been deeply engaged in the ongoing Fed framework review. I have written papers, participated in multiple conferences, commissioned policy briefs, recorded podcasts, written newsletters, and contacted Fed officials about the framework review. Through these efforts, I’ve had two main objectives: (1) to urge the FOMC to adopt NGDP as a cross-check on their traditional economic indicators, and (2) to help ensure they don’t throw out the makeup policy baby with the FAIT bathwater.
Despite these efforts, I was beginning to come to terms with the reality that my work had been well-intentioned but ultimately futile. Chair Powell and the FOMC seemed to be signaling a clear retreat from the Flexible Average Inflation Target (FAIT), drifting back toward a more conventional Flexible Inflation Target (FIT). To me, this appeared to shut the door on makeup policy. But I am here to report that my initial impressions were wrong!
After closely reading the May FOMC minutes, I’ve come away with a different—and more optimistic—interpretation. Beneath the surface of this pivot lies a continued commitment to the underlying spirit of makeup policy. The FOMC may be stepping away from FAIT in form, but not entirely in substance. In the remainder of this newsletter, I’ll explain how that spirit still animates the Fed’s evolving framework and explore the practical challenges this implicit commitment may pose for the FOMC going forward.
FAIT Meets the FOMC’s Cutting Board
To see how the spirit of makeup policy remains alive in the Fed’s evolving framework, it is helpful to review what Chair Powell and the FOMC have actually said about the framework review so far.
The first clue about the future of FAIT came from Chair Powell in November 2024 when he was asked by Catherine Rampell what to expect from the framework review. His answer was “the base case should be more like a traditional reaction function where you don’t promise an overshoot. You just target inflation.” This suggested that FAIT’s version of makeup policy was headed to the FOMC’s cutting board.
More recently, Chair Powell delivered the opening speech at the conference for the framework review and had this to say about FAIT’s makeup policy:
In our discussions so far, [FOMC] participants have indicated that they thought it would be appropriate to reconsider the language around shortfalls. And at our meeting last week, we had a similar take on average inflation targeting.
Here, Chair Powell is referring to the May 2025 FOMC meeting. In that meeting, the average inflation targeting language in the consensus statement was the key issue in the framework being considered. Here is what the FOMC was thinking as reflected in the minutes:
Participants discussed the advantages and disadvantages of flexible average inflation targeting, under which monetary policy seeks to make up for persistently below-objective inflation to achieve average inflation of 2 percent, and flexible inflation targeting, under which policy seeks to return inflation to 2 percent without making up for previous deviations from target... Participants noted, however, that the strategy of flexible average inflation targeting has diminished benefits in an environment with a substantial risk of large inflationary shocks or when ELB risks are less prominent. Participants indicated that they thought it would be appropriate to reconsider the average inflation--targeting language in the Statement on Longer-Run Goals and Monetary Policy Strategy
This language strongly suggests the average inflation targeting language in the consensus statement will not make it past the FOMC cutting board. It is likely to be gone when we get the next consensus statement at the Jackson Hole conference in August 2025.
So is this the end of makeup policy at the Fed? It might be tempting to say yes, but at the end of that same paragraph there was a big reveal that suggests otherwise.
The Spirit of Makeup Policy is Alive and Well
Right after the FOMC decides to bury FAIT in that paragraph, it goes on to say this about FIT:
Participants… viewed flexible inflation targeting as a more robust policy strategy capable of correcting persistent deviations of inflation from either side of the Committee's 2 percent longer-run objective.
This sentence is significant! It reveals the spirit of makeup policy is alive and well at the FOMC. By emphasizing the need to correct "persistent deviations of inflation from either side" of the 2 percent goal, the FOMC is signaling it wants the reintroduction of FIT in the revised consensus statement to have some memory! Put differently, this language indicates past misses in the inflation target will not always be treated as bygones. Instead, persistent undershoots or overshoots may still shape the path of future policy. The inflation target, in short, isn’t purely forward-looking, it retains a shadow of its recent history. That is remarkable!
The FOMC’s Challenge
So the FOMC wants a FIT framework that is “capable of correcting persistent deviations of inflation from either sides” of the 2 percent target. That keeps the door open for makeup policy when it is needed.
Elsewhere, Chair Powell and the FOMC also have expressed a desire to avoid responding to deviations of inflation from its target if they are caused by negative supply shocks. Instead, the Fed should “look through” such shocks.
Putting these two desires together implies that what FOMC really wants is a FIT framework that is “capable of correcting persistent demand-driven deviations of inflation from either sides” of its target. But there are challenges to implementing this vision of FIT as noted by Powell in a 2023 speech:
[F]or many years, it has been generally thought that monetary policy should limit its response to, or "look through," supply shocks to the extent that they are temporary and idiosyncratic… Our experience since 2020 highlights some limits of that thinking. To begin with, it can be challenging to disentangle supply shocks from demand shocks in real time… [Also, supply] shocks that drive inflation high enough for long enough can affect the longer-term inflation expectations of households and businesses. Monetary policy must forthrightly address any risks of a potential de-anchoring of inflation expectations
So how can the Fed implement a FIT that (1) responds to persistent, demand-driven deviations of inflation from target while ignoring supply shocks and (2) keeps long-term inflation expectations firmly anchored? A straightforward way to achieve this vision is to anchor the FIT regime to a stable growth path of total dollar spending. Doing so would allow the Fed to tolerate short-run inflation fluctuations caused by supply disturbances, while still providing a credible nominal anchor that keeps expectations in check. And by targeting a stable path for total dollar spending, the Fed would automatically correct for demand-driven misses in inflation—preserving the spirit of makeup policy within a more flexible, forward-looking framework. In this previous post, I show how this vision can be translated into revised consensus statement language.
Conclusion
The Fed may be moving away from FAIT in name, but the underlying motivation—to correct past inflation misses and foster a credible nominal anchor—remains embedded in the emerging framework. The spirit of makeup policy lives on, quietly influencing how the FOMC thinks about persistent inflation gaps. Anchoring FIT to a stable path of total dollar spending offers a coherent way to formalize that spirit without the baggage of overshoot promises. As the Fed prepares to unveil its updated framework at Jackson Hole, the opportunity remains to build a regime that is not only flexible, but also meaningfully forward-looking, one that learns from the past without being constrained by it.
Bonus Content
Here I am considering counterfactual worlds with different monetary policy frameworks. See which world I end up choosing!
Update
A friend reached out to me and asked why I failed to mention that the May 2025 FOMC minutes also had this to say:
Participants also noted that the Committee's strategy should reflect its willingness to make forceful use of all available tools as appropriate should the risks of hitting the ELB again materialize.
Fair question. This sentence is speaking to the willingness of the FOMC to forcefully use its balance sheet and forward guidance should there be the reemergence of the ELB. These tools are important for how the Fed could do makeup policy. My post was more narrowly focused on the question of whether the Fed would do makeup policy at all. However, the FOMC endorsing the tool set needed to do monetary policy with memory can be seen as further evidence that the spirit of makeup policy is alive and well at the FOMC.
I applaud your efforts to salvage the make-up baby, and press for NGDPLT generally, but what about the statutory mandate? "Stable prices" seem to stand squarely in your way. If they mean the CPI or PCE index, as the "I" in FAIT, some mushy version of the latter is the best we can ever get. But Skandia Amaranth was on the mark in your recent musing with him: "The inflation is ultimately tied to the nominal size of the economy, nominal income growth, nominal spending. Again, if you anchor that one part, you’ve done your job and you allow inflation to temporarily go up, go down. It will, over the medium run, be anchored."
How then to "anchor that one part" if you must at all times be pursuing "stable prices"? The answer, in Skandia's phrasing, is to tie "inflation" to the nominal size of the economy, most easily PCE itself (the aggregate, not the index). Stabilizing total spending stabilizes the dollar value as a share thereof, the only sensible definition of stability in a world of ceaselessly changing real consumption, which must and should "destabilize" individual prices. You and other proponents of NGDPLT have argued for it in those terms but never to my knowledge taken the essential, conceptual step, which is to focus on the dollar value as the essence of "stable prices". It was to be that of a gold quantum under the FRA as enacted in 1913. Share of stabilized total spending is the logical modern successor and would untie the mandate's Gordian knot, which is currently tying it up pretty well. If of interest, the following makes the case a little more fully - and topically.
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Heads are currently being scratched over what the Federal Reserve should do if faced with a recession brought on by a trade war. How, under its statutory “dual mandate”, can it loosen credit to maximize employment, as threatened by the tariffs, and also tighten it to maintain “stable prices”, as forced up by them? The answer lies in a common sense reconsideration of the latter term.
The Fed’s preferred measure of “stable prices” is the Personal Consumption Expenditures (PCE) price index, but to forestall recession the need is to stabilize aggregate demand, the sum of prices paid, not an index of them. A growing number of economists advocate targeting a certain level of GDP, but the better solution, compliant with the statute, would be to stabilize total consumer spending, i.e., PCE itself.
Doing so would be much the same thing, more easily done. PCE represents 68% of GDP and moves in tight correlation to it. It can be and is reported monthly by the government, well ahead of the more complex, quarterly GDP, the other components of which (investment, government spending and net exports) are less relevant to consumer prices. A recent proof of PCE’s utility as monetary tool is offered by the inflation explosion of 2021-2022. Consumer spending began accelerating in early 2021. For various reasons (still debated) the Fed did not even begin to react until March of 2022. By that time PCE had risen by 17%, driving the CPI up by 10%. Meanwhile credit card debt, being short term, continuously observable, and a primary fuel for consumer spending, could easily have been restrained by the Fed.
As for the mandate, stabilized consumer spending has its own strong claim to price stability.
The “real” value of what consumers buy is not directly observable, if only because it is subjective. Over time, however, it must logically equal nominal spending deflated by a price index. The PCE index will serve for that purpose, at least over time periods long enough to balance its flaws, up and down. Real U.S. consumption growth as so measured, from 1970 to the present, has averaged about 3% per annum, suggesting that the stabilization of PCE growth at 5% would produce long-term average inflation of about 2% – the very thing the Fed now seeks using the complex tools that instead produced the 2021-2022 fiasco.
The inflation component of the 5% would of course be an average only, as real consumption changed, but the spent dollar, as a constant share of a stabilized total, would be “stable” in a way that individual prices never can be, or should, in perpetually changing conditions.
When gold was “money” it worked in much this way. The world’s total stock of it grew at roughly the rate of human economic activity, so that the total amount of it spent (and not worn or hoarded) did too, a given amount representing a roughly constant share of the total. Borrowers’ debts were not made unpayable in hard times, as they might be if equated (as by an index) to a basket of things that were unexpectedly scarce. Gold was pretty constantly so. Lenders were protected but also shared in unexpected real growth. We don’t know which it will now be, feast or famine, but stabilized total spending would work similarly in a recession. Fewer businesses would fail and consumers, the special wards of the mandate, would see their credit card rates fall, driven down by the Fed to maintain the total spending level.
The Fed was set up in 1913 to stabilize the banking system and provide an “elastic” currency that could expand and contract, but around a stable value, that of gold at the time. The task is newly-critical in the face of uncontrolled government spending. As to what that value should be, what better successor to gold than a share of consumption in the world’s largest economy? As to the mandate, Congress could hardly have meant to freeze the Fed in its headlights just as a recession loomed in the road up ahead.
David Patterson, Dpatterson@bganyc.com, www.brandytrust.com
"the baggage of overshoot promises?"
FAIT certainly allows a period of over target inflation that moves the PL trajectory above a previous trajectory if that is what is required to restore full employment after a shock -- that is guess is the "overshoot," but where is the "promise?"