“[I]f inflation runs below 2 percent following economic downturns but never moves above 2 percent even when the economy is strong, then, over time, inflation will average less than 2 percent. Households and businesses will come to expect this result, meaning that inflation expectations would tend to move below our inflation goal and pull realized inflation down. To prevent this outcome and the adverse dynamics that could ensue, our new statement indicates that we will seek to achieve inflation that averages 2 percent over time. Therefore, following periods when inflation has been running below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time.”
Jerome H. Powell, August 27, 2020
Monetary policy regimes rarely change. On 27 August 2020, in a public webcast speech at the annual Jackson Hole symposium, the Federal Reserve’s most visible conference, Federal Reserve Chair Jerome H. Powell announced such a change. The Federal Reserve was formally adopting a new strategy that he termed a “flexible form of average inflation targeting” (AIT), which ensures that the Fed’s inflation objective of 2% is obtained on average. Following more than a year of internal discussions, conferences with academics, and meetings with the general public as part of a Fed Listens series, this announcement received extensive news coverage. As described by Powell, the main difference between AIT and traditional inflation targeting (IT) is that, under the former regime, a period of below-target inflation should be followed by a period in which inflation is systematically above the target, whereas under the latter regime, inflation should move to its target regardless of how long it had deviated from it previously. This promise of higher-than-normal future inflation under AIT during times of economic distress (when inflation is low) should raise inflation expectations, thereby reducing ex-ante real rates and stimulating the economy as households increase their consumption. Consistent with this mechanism, AIT and similar regimes such as price-level targeting have long been found to have a profound stabilising role in New Keynesian models (Woodford 2003).
At the heart of this mechanism is the notion that the specific inflation targeting strategy followed by the central bank is known and understood by households and firms, leading to materially different dynamics of inflation expectations. But was this the case following Powell’s speech officially announcing AIT? In a recent paper (Coibion et al. 2020), we study this question using a daily survey of US households running before and after Powell’s speech. The survey is used to answer three questions. First, did the general public learn about the announcement? Second, did those households that heard or read about the announcement understand it and incorporate it into their expectations? Third, if we sidestep the thorny issue of how to reach the broader public and instead directly provide pertinent information to households about average inflation targeting, does this affect their beliefs meaningfully relative to traditional inflation targeting? Our survey evidence suggests that the answer to all three questions is in the negative.
Did households learn about the announcement?
To study the extent to which households heard about and understood the AIT announcement, we used a new module inside of a larger daily survey of consumers sponsored by the Federal Reserve Bank of Cleveland. We detect only a very small uptick in the fraction of the population that reported having heard news about the Federal Reserve in the days immediately following the announcement. This finding suggests that the announcement did not significantly affect the general public’s perception of monetary policy. The share of households reporting that they heard any news about monetary policy or the Federal Reserve rises from 24% on the day prior to the announcement to a high of just 33% on the day after the announcement, before falling thereafter. While some respondents claimed to have heard Fed-related news from official sources, most reported having read about it in the newspaper or on social media, or having heard about it on television or the radio. Less than half of the people who heard Fed-related news after the announcement reported that the news was about a new strategy by the Federal Reserve. Despite extensive coverage in the news media, Powell’s speech apparently did not reach or register with the vast majority of the population.
Did hearing about the announcement affect beliefs?
Even for those who heard news about monetary policy following the announcement, the news had little impact. For example, those who reported hearing news about monetary policy after the announcement were not more likely to report AIT as a Fed strategy than respondents prior to the announcement. Both before and after the announcement, respondents were more likely to select IT as a Fed strategy than AIT. They were also no more likely to report that maximum employment and price stability were the two main objectives of the Federal Reserve. Instead, both before and after the announcement, respondents were more likely report that the main objectives of the Federal Reserve were maintaining a strong dollar and keeping interest rates low to reduce the government’s cost of borrowing than to report maximum employment and price stability. Conditional on receiving news after the announcement, households’ expectations about inflation, output growth, and personal income were effectively unchanged as well. In short, we find no evidence that being exposed to news about monetary policy or the Fed after Powell’s speech changed households’ perceptions of what the Federal Reserve will do, and nor did it affect their broader economic outlook.
What is the potential for average inflation targeting to affect household expectations?
While this announcement may not have had any meaningful effect on the public’s perception of the monetary policy strategy, it does not rule out the possibility that, when presented directly and concisely to individuals, information about AIT could lead households to change their beliefs in a manner consistent with the theory. We experimentally address this question. Specifically, we randomly provide some individuals with information explaining AIT, while others receive information on IT, and a third group receives no information (control group). Providing information about either AIT or IT leads average Americans to have lower medium-term expectations for future inflation, future GDP growth, and their own personal household income growth. At the same time, we find no meaningful differences in expectations between individuals who are provided information about AIT versus IT. Even when information about the new inflation strategy is presented directly to households and the strategy is clearly explained to them, it does not lead to discernibly different expectations than traditional inflation targeting. This suggests that AIT is unlikely to provide many of the economic benefits that theory often attributes to it.
We view these results as a call for caution to those who expect AIT to work as well in practice as it does in the most used policy models. A large body of work has documented the existence and importance of numerous information frictions that can hamper the forward-looking mechanisms that drive important models (see Angeletos et al. forthcoming, for a recent example). Our results build on this literature and provide new evidence on the limited pass-through of central bank communications to the broader public. While the “Fed Listens,” the public may not.
Authors’ note: The views expressed herein are those of the authors and do not necessarily reflect the views of the Federal Reserve Bank of Cleveland, the Federal Reserve System, or any other institution with which the authors are affiliated.
Angeletos, G-M, Z Huo and K A Sastry (2020), “Imperfect Macroeconomic Expectations: Evidence and Theory”, in NBER Macroeconomics Annual, National Bureau of Economic Research, forthcoming.
Coibion, O, Y Gorodnichenko, E S Knotek II and R Schoenle (2020), “Average Inflation Targeting and Household Expectations”, Federal Reserve Bank of Cleveland, Working Paper No. 20-26..
Woodford, M (2003), Interest and Prices: Foundations of a Theory of Monetary Policy, Princeton University Press.