During the Jackson Hole Symposium yesterday, Federal Reserve Chairman Jerome Powell announced the adoption of Average inflation Targeting (AIT), a monetary policy tool that will stimulate the rise of inflation level above the Fed’s 2% target, something that the central bank has failed to do so for many years over the past decade. Traditionally, the Fed aims to achieve their 2% inflation target on a yearly basis. But with the adoption of AIT, the Fed will now aim to achieve that target over a period of time, making it easier for the target to be hit.
The adoption of AIT also implies that when unemployment rate falls, the Fed is less likely to raise interest rates so long as inflation level does not surpass the central bank’s acceptable range. Under this new approach to inflation, a decline in unemployment rate is less likely to cause a jump in inflation due to its “averaging effect” whereby inflation levels will be smoothened out across a period of time (a similar effect as the moving average). Thus, the Fed will be able to keep interest rate low for a longer period.