Make-Up Policy: Where Art Thou?
As we head into the second half of the year, the swift recovery many were hoping for is facing an uncertain future. The resurgence of the COVID-19 virus and concerns about dwindling fiscal support have many worried. I submit that even in the absence of these worries, the recovery would still be on shaky grounds without the Fed explicitly committing to 'make-up' policy. Make-up policy is an explicit framework that allows the Fed to correct for past misses in its target. In the case of a recession, this feature allows the FOMC to be fine with inflation temporarily overshooting its target while the economy bounces back. Tolerating this overshoot implies a similar surge in nominal income that would restore it to the levels expected by household and business prior to the crisis. This restoration is important since many fixed-price nominal financial obligations like mortgages, loans, and leases were made based on these forecasts of nominal income. Without make-up polic...