John C Williams: The theory of average inflation targeting

Remarks (via videoconference) by Mr John C Williams, President and Chief Executive Officer of the Federal Reserve Bank of New York, at the Bank of Israel/CEPR Conference on "Inflation: Dynamics, Expectations, and Targeting", 12 July 2021.

Central bank speech  | 
12 July 2021

Good afternoon, and thank you, Governor Yaron, for that kind introduction. It's truly a pleasure to speak at this conference.

So much has happened in the world and in monetary policy in the year and a half since the onset of the COVID-19 pandemic. However, I will not use my time today to discuss the specific challenges posed by the pandemic. Rather, I will return to a topic that predates COVID-19 and will be critically important for central banks in the post-pandemic era: How inflation targeting should evolve to be successful in the context of a global economy characterized by very low neutral interest rates.

I will start by describing the challenges that the combination of the very low level of real neutral interest rates and the lower bound on nominal interest rates pose for standard versions of inflation targeting. I will then summarize the theoretical underpinnings of what is commonly referred to as Average Inflation Targeting, or AIT for short. I will focus on the key characteristics of various versions of AIT and how they can help mitigate the deleterious effects of the lower bound on interest rates on macroeconomic outcomes. I should be clear from the start that the goal of my presentation is to engage in the broad academic and central bank discussion on monetary policy strategies, and that this is not, and should not be interpreted as, a description of the Federal Reserve's new policy framework or the practical application of AIT to real-world situations. I would also be remiss not to mention that most of what I discuss today is based on research conducted with my esteemed colleague Thomas Mertens at the Federal Reserve Bank of San Francisco.