St. Louis Fed’s Bullard Discusses “Is the Fed ‘Behind the Curve’? Two Interpretations” at the Hoover Institution

STANFORD, Calif. –Federal Reserve Bank of St. Louis President James Bullard provided updated estimates of the degree to which the Federal Reserve is “behind the curve” (PDF) on raising its policy rate in response to high inflation in the U.S. He spoke Friday at an event hosted by Stanford University’s Hoover Institution.

Bullard highlighted two interpretations of “behind the curve,” incorporating more recent data since his April 7 and April 21 presentations on this topic.

• In the first interpretation, he used the latest Dallas Fed trimmed mean inflation rate—the most generous (lowest) interpretation of the persistent component of current inflation—along with other “generous assumptions” in a Taylor-type policy rule to get a minimal recommended value for the policy rate under current macroeconomic conditions. The recommended policy rate from the minimalist policy rule calculation is 3.63% (363 basis points), while the current value of the policy rate is 87.5 basis points. Thus, the current policy rate is below the minimalist recommendation by 275 basis points, Bullard said
• In the second interpretation, Bullard suggested that the 2-year Treasury yield may provide a better representation of where Fed policy is likely to be in the near future, because of the forward guidance the Fed has given since the fourth quarter of 2021. The value of the 2-year Treasury yield on May 5 was 2.71%, about 90 basis points shy of the rate recommended in the first calculation, he said.

Generously defined Taylor-type monetary policy rules, even if based on a minimum interpretation of the persistent component of inflation, still recommend substantial increases in the policy rate, Bullard said. He added that the Fed is far “behind the curve” by this first interpretation.

However, he noted that the first interpretation does not take into account Fed credibility or its use of forward guidance. “Credible forward guidance means market interest rates have increased substantially in advance of tangible Fed action. By this second definition of ‘behind the curve,’ the Fed is not as far behind, but it must now increase the policy rate to ratify the forward guidance previously given,” he said.