Inflation and the Fed’s new framework in the time of Covid-19 by Gauti Eggertsson, Alessandro Lin, Josef Platzer, Luca Riva published by VOXEU (3/2022).
The Fed recently introduced an average inflation targeting framework, in which past inflation shortfalls shape current policy. This column assesses this policy relative to alternatives in the context of the Covid-19 recession and recovery. The authors calibrate a simple New Keynesian model at the zero lower bound to replicate the Fed’s policy, finding that the new framework substantially reduced the US output contraction by about 40%. Alternative policies would have reduced the contraction by even more. The results suggest that the Fed places some weight on output stabilisation alongside inflation.