Enhancing resilience with natural growth targeting

Abstract

Despite a number of helpful changes, including the adop-tion of an inflation target, the Fed's monetary policy strat-egy proved insufficiently resilient in recent years. Whilethe Fed eased policy appropriately during the pandemic,it fell behind the curve during the post-pandemic recov-ery. During 2021, the Fed kept easing policy while theinflation outlook was deteriorating and the economy wasgrowing considerably faster than the economy's naturalgrowth rate—the sum of the Fed's 2% inflation goal andthe growth rate of potential output. The resilience of theFed's monetary policy strategy could be enhanced, andsuch errors be avoided with guidance from a simple natu-ral growth targeting rule that prescribes that the federalfunds rate during each quarter be raised (cut) when pro-jected nominal income growth exceeds (falls short) of theeconomy's natural growth rate. An illustration with real-time data and forecasts since the early 1990s shows thatFed policy has not persistently deviated from this simplerule with the notable exception of the period coincidingwith the Fed's post-pandemic policy error.