The Federal Reserve’s move to an explicit inflation target: incremental policy shifts in techno-political institutions

Abstract

This paper analyzes the US Federal Reserve (Fed)’s landmark 2012 decision to adopt an explicit inflation target for the first time in its history. The paper focuses on explaining the dynamics of this policy shift. The relevant literatures authoritatively establish types of incremental change and the transformative nature of this kind of change. Using the case of the Fed’s policy shift, this paper advances a framework for explaining when the likelihood of such change increases, and how ‘policy entrepreneurs’’ strategies can affect this likelihood. Its theoretical discussions are broadly applicable to other techno-political institutions. The paper’s evidence comes from previously non-public internal Fed transcripts, and its discussions draw from diverse literatures – on the Fed and central banks, on multilateral economic institutions with similarly techno-political characteristics, historical institutionalism, as well as Macroeconomics.

Keywords:

• Federal Reserve
• Fed
• inflation
• inflation targeting
• policy shift
• incremental change
• historical institutionalism

Acknowledgements

The author is grateful to colleagues from Swarthmore’s Economics Department, especially the late Steve Golub and Mark Kuperberg for many great conversations on the Fed and macroeconomics. She also acknowledges her Swarthmore students, Matt Salah, Simran Singh, and Doug Leonard for outstanding research assistance. She is grateful to Orfeo Fioretos for discussions on historical institutionalism and to Ben Braun for useful feedback on earlier drafts of this piece. She also thanks all the participants at numerous ISA annual conventions for discussions on central banking.

Disclosure statement

No potential conflict of interest was reported by the author.

FOMC Documents

FOMC. (2012). Statement on longer-run goals and monetary policy strategy. January 24. www.federalreserve.gov

FOMC Meeting Transcripts: 06/29/2006; 10/24-25/2006; 09/18/2007; 01/31/2007; 12/16/2008; 03/20/2007; 01-02/11/2011;11/01-02/2011; 01/24-25/2012; 01/25/2012; 03/20-21/2017.

Notes

1 As measured by the annual change in the price index for personal consumption expenditures (PCE). FOMC has twelve members: the seven members of the Board of Governors of the Federal Reserve System; the president of the Federal Reserve Bank of New York; and four from the rest of the eleven Reserve Bank presidents (on a rotation).

2 E.g. Spicer (2012) and Harding (2012).

3 E.g. Fleming (2018) and Summers (2018). Binder and Spindel (2018) and Shapiro and Wilson (2019) also emphasize the importance of the policy change. Mukherjee and Singer (2008) identify inflation-targeting as an important but under-researched area in Political Science.

4 Radical change is uncommon and tends to unfold rapidly (Krasner et al., 1984; True et al., 2007; Weyland, 2008, p. 282); incremental change happens ‘gradually and continuously’ (Streeck & Thelen, 2005, p. 18; also Mahoney & Thelen, 2010, p. 205). Kaya and Reay (2019) introduce fragmented change.

5 The Fed is a political actor also because its policies have widespread distributional repercussions (e.g., Jacobs & King, 2016). Being a political actor is distinct from claims about whether Fed officials have partisan inclinations.

6 There may be other advantages to delegation, such as scapegoating, (see Binder & Spindel, 2018).

7 Central banks’ ‘specialized macroeconomic expertise’, in turn, supplies them with legitimacy (Johnson, 2006, p. 365; Marcussen, 2006). On the importance of central banks to macroeconomics, see Claveau and Dion (2018).

8 For relevant work on the technical underpinnings of economic policy ideas, see, for instance, Blyth (2002), Chwieroth (2010), Widmaier (2016) and Farrell and Quiggin (2017).

9 The notion of inflation nutters was coined by Mervyn King of the Bank of England and is used by Bernanke in articulating his commitment to the duality of the mandate (FOMC 06/29/2006).

10 The ECB’s actions since 2008 have produced a vibrant literature: e.g. Braun (2016), Klooster and Fontan (2019) and Diessner and Lisi (2019).

11 For example, Chwieroth (2008a, 2008b) focuses on policy entrepreneurship within these international institutions.

12 The aforementioned literature’s categorization of different types of incremental change – layering, conversion, drift, and displacement – has deservedly been influential. Here, I do not aim to categorize change; rather, I focus on the factors that affect the likelihood of policy shifts.

13 The notion of an organizational purpose, merely and uncontroversially assumes organizations have their own unique cultures that are not static but nonetheless filter, interpret, and shape events (e.g. Barnett & Finnemore, 1999). Organizational fit matters because techno-political institutions generally belong to transnational ‘epistemic communities’ (e.g. Johnson, 2006; Marcussen, 2006).

14 Work on techno-political institutions suggests principal-incompatible shifts are unlikely despite institutional autonomy (e.g., Hawkins et al., 2006).

15 For recent work that connects what I call techno-political institutions, see Ban and Patenaude (2019) on the ECB and IMF staff.

16 On legitimacy, see, e.g. Hurd (1999), Buchanan and Keohane (2006) and Reus-Smit (2007). Tallberg and Zürn (2019) discuss how authority, procedures, and performance of IOs affect their legitimacy.

17 As Braun et al. (2020) explain, because central banks intermediate between the private (markets) and public (official governance) realms, principal-agent frameworks may not suffice.

18 On how political salience of issues interfere with political entrepreneurs’ reform initiatives, see Culpepper (2011).

19 IT thus owes its origins to the Friedman-Phelps (Friedman, 1968) revolution on the absence of a long-run Phillips Curve and the emphasis on rational expectations (Freedman & Laxton, 2009).

20 After the 2012 decision, in the 113^th Congress, there was a Republican-supported bill (H.R.1174) calling for a single mandate, which did not materialize.

21 Behavioral economics suggests people tend to be status-quo oriented (e.g. Kahneman, 2011). For a similar finding on the IMF, see Clift (2018).

22 The original Taylor Rule is: $i_t=\mathrm{ }\mathrm{ }\pi +\mathrm{ }.5\left(\pi -2\right)+.5y+2\mathrm{ };$ where $\pi$ is the inflation rate; y is the real GDP gap; it indicates the interest rate rises if inflation or y increases above 2.

23 Prior to this, the FOMC published its forecasts twice a year in its Monetary Policy Report; the SEP provides more disaggregated information more frequently.

24 The appropriate policy basically denotes the policy path to the desired economic outcomes.

25 Shapiro and Wilson (2019) suggest the low inflation in the wake of the recession facilitated the convergence toward 2%, which my own calculations also confirm (see Supplementary material, Appendix A).

26 The FOMC, hence, interpreted consensus as general agreement.

Additional information

Notes on contributors

Ayse Kaya

Ayse Kaya is currently Associate Professor of Political Science as well as co-founder and co-coordinator of the Global Studies Program at Swarthmore College (in Swarthmore, PA, USA). Her research focuses on multilateral economic institutions and the Federal Reserve.