Average Inflation TargetingEdit
Average Inflation Targeting
Average Inflation Targeting (AIT) is a monetary policy framework in which a central bank aims to achieve a specific inflation rate on average over time, rather than at any given moment. The core idea is to maintain price stability while giving policy space to support employment during downturns. Under AIT, a central bank allows inflation to run moderately above the usual target for a period, to compensate for times when inflation ran below target, so that the long-run average remains anchored around the goal. Proponents say this makes it easier to support jobs without sacrificing credibility on price stability; critics fear it can blur the anchor and invite inflationary mistakes. The approach has been adopted in varying forms by several large economies and remains the subject of ongoing debate among policymakers, scholars, and financial markets. central bank inflation monetary policy inflation targeting PCE price index Federal Reserve System
The basic logic behind AIT is to reduce the opportunity cost of monetary easing during recessions while still keeping long-run inflation expectations anchored. By allowing a temporary overshoot after a period of undershooting, a central bank signals that it will not slam the brakes too aggressively when unemployment is elevated, thereby supporting the labor market without abandoning its commitment to price stability in the long run. In practice, the framework often centers on a target such as a 2 percent inflation rate on average over time, with the understanding that a single year’s inflation reading is not the sole guide for policy. Inflation targeting 2 percent inflation target FOMC
Origins and design
Conceptual roots: AIT grew out of broader discussions about flexible inflation targeting and the time inconsistency problem in monetary policy. Rather than treating the target as a fixed ceiling at every moment, many central banks embrace a symmetric, make-up approach: if inflation undershoots the target for a stretch, policymakers will try to overshoot a bit in the future to compensate. This is intended to preserve credibility while avoiding abrupt policy changes in the face of transitory shocks. monetary policy inflation targeting
How it works in practice: AIT typically ties the objective to an average over a horizon, such as a couple of years, rather than a strict, point-by-point symmetry. The details vary by institution, but the common thread is that inflation running below target provides room to avoid immediate tightening, and inflation running above target creates the expectation of a slower pace of further tightening once the average target is approached. The preferred inflation measures matter too; in the United States, for example, the PCE price index is the standard for guidance, while other economies sometimes emphasize the CPI. Personal consumption expenditures price index inflation central bank independence
Measuring the target: The idea is to anchor expectations over the longer run, not to compel a fixed rate every quarter. This makes it easier for households and firms to plan, while still keeping the central bank honest about price stability. If the public trusts that the average will be kept around the goal over time, the policy can be more effective at stabilizing both prices and employment. inflation targeting central banking
Adoption and practice
The United States: The Federal Reserve adopted a form of AIT in 2020, signaling that it would seek to achieve 2 percent inflation on average over time and that it would not lie dormant if inflation ran above target for a period in order to make up for earlier undershoots. The move was presented as a way to support maximum employment while preserving price stability as the central bank’s core objective. The Fed’s communication drew on a broad literature about making up for past inflation shortfalls without creating a credibility gap. Federal Reserve System FOMC inflation targeting
The Bank of England and the European Central Bank: Other major central banks operate with symmetric but flexible targets, emphasizing price stability with a bias toward supporting growth and employment when appropriate. While not always labeled as AIT, these institutions use similar logic—allowing some deviation from a strict target to avoid policy mistakes and to keep credibility intact. Bank of England European Central Bank inflation targeting
Other players: Central banks in Canada, Australia, and many emerging markets have explored or implicitly incorporated make-up features in their frameworks, often blending them with rule-based elements or with explicit forward guidance. The diversity of designs reflects differing macroeconomic conditions, legal frameworks, and political economies. Monetary policy central bank independence
Economic effects and debates
Potential benefits: Support for employment during weak demand, smoother policy responses, and reduced risk of excessive tightening in the wake of temporary declines in inflation. In theory, the approach can help restore and maintain full employment without sacrificing long-run credibility on price stability. Advocates emphasize that credible inflation targeting remains intact because the “average” over time still centers on a clear goal. employment inflation price stability
Potential costs and concerns: Critics worry that an average-target framework can muddy the communication of policy, making it harder for households and markets to interpret future actions. If inflation expectations become less anchored, the inflation outlook may become more volatile, and the central bank could face higher interest rate volatility to re-anchor expectations. There is also the concern that making up for past undershooting could be used to justify higher inflation in the future, potentially eroding the real value of money for savers and retirees and complicating long-run planning for households. Critics also argue that the framework may enable governments to borrow more cheaply by relying on inflation to erode debt, raising questions about fiscal-miscal management and the long-run sustainability of deficits. central bank independence inflation expectations fiscal policy
Distributional and international considerations: Inflation does not affect all groups equally. Fixed-income households and small savers can bear the burden of higher prices, while borrowers may gain from reduced real debt burdens in the short run. The degree of impact depends on the timing and persistence of inflation, the structure of wages, and the health of the labor market. Internationally, AIT can influence exchange rates and capital flows, as different countries’ frameworks may diverge in how they balance growth and price stability. savers households exchange rate capital flows
Controversies and debates from a practical, market-minded perspective
Credibility and time consistency: A core critique is that “average” targets depend on credible commitment. If market participants doubt the central bank’s willingness to pursue make-up periods, inflation expectations may drift upward or downward, defeating the purpose of the framework. Proponents counter that a well-communicated average target reduces the risk of abrupt policy shifts and anchors expectations more reliably than a rigid symmetry rule. monetary policy inflation expectations central bank credibility
Labor markets versus price stability: The rationale for AIT rests on a trade-off between short-run employment support and long-run price stability. Critics claim the approach can sow longer-run inflation risk if the public tunes expectations to a higher path. Supporters respond that the framework provides a structured way to avoid snappy rate hikes or premature tightening when unemployment is elevated, while still preserving the long-run anchor. unemployment price stability
Fiscal space and moral hazard: AIT has sparked debate about its interaction with public debt and fiscal policy. By allowing inflation to run a bit higher, the real value of existing debt can erode, which some view as a form of soft fiscal relief. Critics worry this blurs the boundary between monetary and fiscal domains and may erode incentives for prudent budgeting. Proponents argue that the central bank should focus on achieving its price-stability mandate with flexibility, while fiscal policy remains the primary tool for addressing long-run debt dynamics. fiscal policy debt central bank independence
The “woke” critique and its deflationary critique of policy design: Some critics frame AIT as a political instrument that willfully emphasizes employment or social outcomes at the expense of price certainty. They may argue that this is a drift away from strict rules and toward discretionary policymaking. From a practical, market-oriented perspective, such critiques often overstate the distributional reach of monetary policy and misunderstand the stability a credible inflation target can provide for all segments of the economy. Those who reject this line of critique contend that well-communicated, pragmatic policies—focused on long-run stability and credible rules—serve the interests of households and firms alike, and that moralizing about “wokeness” is irrelevant to the technical performance of the framework. In the end, the evaluation rests on how well the framework preserves credibility, supports employment, and keeps inflation expectations well-anchored over time. central bank independence inflation targeting employment
Alternatives and comparisons: Critics often compare AIT to other approaches such as strict inflation targeting, price-level targeting, or nominal GDP targeting. Each framework has trade-offs. Proponents of AIT emphasize its ability to smooth the business cycle without sacrificing the long-run price anchor; proponents of alternative rules argue for more explicit, rule-based guidance that reduces ambiguity. The choice among these options depends on country-specific goals, institutions, and the resilience of the financial system. monetary policy price-level targeting nominal GDP targeting
See also