Because of the long-run decline in interest rates, the Federal Reserve cannot stabilize output and inflation in downturns as much as before. To counteract that problem, the Fed has begun exploring strategies for "making up" for inflation shortfalls. These strategies are expected to also stabilize output. This article discusses how these make-up strategies differ from the Fed's previous monetary strategy; it describes different possible make-up strategies; and it explores make-up strategies' advantages and disadvantages. The Fed's new make-up strategy calls for letting rates rise more slowly than otherwise following longer periods of inflation below the Fed’s target. This would allow inflation to average 2 percent during a certain window of time. But this make-up strategy represents an evolution of policymaking, not a revolution overturning past practices.
This article appeared in the Fourth Quarter 2021 issue of Economic Insights. Download and read the full issue.
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