As discussed in last week’s Economics Weekly, the Warsh-led Fed appears to be looking to jettison the reaction function of more recent FOMCs, but Warsh is seemingly waiting to announce what its replacement will be. Warsh also seems to be suggesting that he would like investors to take on more risk themselves and rely less on any hand-holding and moral suasion from the Fed. This likely means the strike price for the Fed put is now lower, and investors may have to stomach a little more volatility in the future.
In many ways, this feels like Nassim Nicholas Taleb’s antifragile approach to monetary policy. It also seems sensible in a world where the inflation regime has shifted and where inflation risks are now either symmetrically or even asymmetrically skewed to the upside, as opposed to being solely to the downside from 2000 to 2020.
Under this new regime, where inflation is harder to predict and more prone to rise, the Fed’s reaction function necessarily needs to be tweaked, and Warsh is right to want to at least question the nature and measurement of the inflation metrics that the Fed uses to gauge inflation’s proximity to its target. In this Economics Weekly, Richard de Chazal discusses some of the alternative measures of inflation and what might be the best approach in this uncertain environment.