The Federal Reserve's average inflation target has faced criticism, but after framework evaluation, it may only undergo minor adjustments

According to the Zhitong Finance APP, the Federal Reserve will complete its policy framework assessment before the end of summer, and its criticized "Average Inflation Targeting" (AIT) strategy may largely remain after the assessment.

In 2020, the Federal Reserve adjusted its policy framework that had been in place for nearly nine years, one of the core changes being the adjustment of the original 2% inflation target to an average inflation target of 2%. Under the original 2% inflation target framework, the Federal Reserve only needed to focus on current changes in inflation expectations without considering the past. However, the adjusted existing framework requires attention to the average inflation level over a certain period, meaning that if inflation remains below 2% for a certain period, the Federal Reserve would tolerate inflation exceeding 2% in subsequent periods to avoid prematurely tightening policies that could negatively impact the labor market.

The average inflation targeting strategy—regardless of how vague the time frame may be—allowed the Federal Reserve to see "temporary" inflation rises and ensured that it would not unnecessarily suppress employment due to rapid policy tightening during an economic downturn. Many attribute the Federal Reserve's reluctance to tighten monetary policy amid soaring inflation in 2021 partly to this strategy, arguing that its lagging response exacerbated the risk of runaway inflation.

In hindsight, this adjustment by the Federal Reserve is viewed by many as clumsy or at least poorly timed. Although the core PCE inflation rate favored by the Federal Reserve has averaged 2.1% over the past 20 years—even accounting for the severe price fluctuations post-pandemic—this figure overlooks the politically sensitive pain caused by rising prices in recent years, the lagging nature of hastily raising interest rates to control inflation, and the reality that current inflation remains high (as indicated by U.S. inflation data from January).

It also exposes a mistake of judging policy success or failure solely based on what has already occurred, with issues often obscured by "averaging." Furthermore, as some central bank peers have pointed out, it avoided preventive policies capable of responding to shocks, which may be necessary in an era of high uncertainty in the coming years.

Federal Reserve Chairman Jerome Powell recently stated in response to questions from U.S. Congress members that this year's framework assessment will reflect on recent experiences, saying, "We will accept criticism and make appropriate, prudent adjustments."

A more useful statistic might be that the average core PCE inflation rate over the past five years has been 3.5%. Market and U.S. household inflation expectations are closer to this level than the Federal Reserve's established target. This change in expectations may be a concern for policymakers, indicating that any adjustments to the framework will focus more on these indicators rather than past inflation rates.

UBS economists stated in a report at the end of last year that they expect the Federal Reserve to "re-establish a more equal footing" between inflation and employment in this year's framework assessment, with greater emphasis on inflation expectations. However, they also noted that the core elements of the average inflation targeting strategy may largely be retained. If so, this could mean that the Federal Reserve is inclined to allow inflation to temporarily fall below the 2% target to balance future average trends. To achieve this, the policy interest rate may need to remain above the "neutral rate" of 3%-3.5% for an extended period after inflation data actually returns to the 2% target, unless there is a significant recession in the labor market UBS's judgment seems to have been validated by Powell's statements. Powell stated at the end of January that the inflation target would not be the focus of the framework assessment, and the Federal Reserve is not interested in revising the established 2% inflation target at all.

This is also indicated by the U.S. inflation data for January, suggesting that the bond market and the broader economy may need to prepare for the Federal Reserve's tough measures later this year, which could anger U.S. President Trump, who is "demanding an immediate rate cut." Furthermore, how to avoid being hamstrung by new shocks will test the Federal Reserve's rhetorical skills in its assessments—many believe this is precisely what the Federal Reserve lacked five years ago