Setting the Record Straight: A Letter to and from the Fed on the Inflation Target:

The Federal Reserve, like other central banks, is conducting a comprehensive review of the monetary policy framework.   In recent day, for example, former NY Fed President Dudley suggested that the Fed may want to consider dropping the Fed funds target altogether as the interest paid on reserves is the real ceiling on short-term rates and the fed funds market is thinly traded.

Before investors and economists can properly evaluate the Fed’s policy framework, they have to understand where it is now.  There seems to be a serious and widespread misunderstanding of the Fed’s inflation target.  An unscientific sample of market participants and business journalists would conclude that the Fed target the core PCE deflator at 2%.

The Fed does often talk about the core rate, but this is not what the Fed targets.  The Fed targets the headline rate.  Many believe so profoundly that the Fed targets that core rate that the assertion could be dismissed.  Of course, do not take my word for it (“of all, one must be skeptical), take the Fed’s.

I wrote a letter to the Federal Reserve last November asking about this.  A copy of the brief exchange is posted here:

Board of Governors of Federal Reserve
System – 

Public Affairs >

January 1, 2019 8:20 pm

Dear Mr. Chandler:

Thank you for your recent inquiry to the Federal Reserve Board.

For the inflation measure, please refer to the FOMC’s Statement on
Longer-Run Goals and Monetary Policy Strategy, last amended on January 30,
2018. (“The Committee reaffirms its judgment that inflation at the rate of
2 percent, as measured by the annual change in the price index for personal
consumption expenditures, is most consistent over the longer run with the
Federal Reserve’s statutory mandate.”) 

From: Marc Chandler marc.c.chandler@>
Date: Thursday, November 29, 2018 12:00 AM
Reference Number: 201800219725

I see different references so can you clarify for me, what is the Fed’s
inflation measure the Fed targets core PCE deflator or the headline PCE
deflator? Thanks. And maybe a separate question too. If the Fed pays interest
on required and excess reserves, why is there references to IOER –interest on
excess reserves instead of IOR?



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