What is Average Inflation Targeting (AIT)?

What is Average Inflation Targeting (AIT)?

Average Inflation Targeting (AIT) is a monetary policy framework wherein central banks aim to achieve a target for inflation over the medium term, typically by targeting an average inflation rate over time, rather than aiming for a fixed inflation rate at all times. This approach allows for more flexibility in responding to economic fluctuations and deviations from the target.

The concept of Average Inflation Targeting gained attention in academic and policy circles over recent years as central banks sought to refine their monetary policy frameworks to better address the challenges of low inflation and economic instability.

Federal Reserve Chairman Jerome Powell introduced Average Inflation Targeting (AIT) in August 2020 during the Federal Reserve's annual Jackson Hole symposium. In his speech, Powell outlined a significant shift in the Fed's monetary policy framework, moving away from its previous strategy of aiming for a fixed 2% inflation target. Instead, the Fed announced it would adopt a more flexible approach by targeting an average inflation rate of 2% over time. Key points from Powell's speech introducing AIT included:

  • Shift from Inflation Targeting to Average Inflation Targeting: Powell announced that the Fed would aim for inflation that averages 2% over time, rather than targeting a specific inflation rate at all times. This means that if inflation has been running persistently below 2%, the Fed may allow it to run moderately above 2% for a period to achieve the average target.
  • Flexible Monetary Policy Approach: The adoption of AIT signaled a willingness on the part of the Fed to tolerate periods of inflation above the 2% target, especially following periods of below-target inflation. This approach aimed to support the Fed's dual mandate of promoting maximum employment and price stability.
  • Enhanced Forward Guidance: Powell also emphasized the importance of enhanced forward guidance to provide additional clarity about the Fed's policy intentions. This forward guidance aimed to reassure markets and the public about the Fed's commitment to its new policy framework.

Overall, Powell's introduction of Average Inflation Targeting represented a significant shift in the Fed's approach to monetary policy, signaling a more flexible stance aimed at achieving both stable prices and maximum employment over the long term.

Other central banks, such as the Reserve Bank of New Zealand, have also considered or adopted similar frameworks. The Reserve Bank of New Zealand announced in 2018 that it would be adopting a dual mandate framework, which includes an explicit employment objective alongside its price stability mandate, and it considers factors such as the maximum sustainable level of employment when making monetary policy decisions. While not identical to AIT, this approach shares some similarities in terms of the emphasis on achieving inflation targets over time and considering broader economic objectives.