More subtly, a central bank following a strategy of “opportunistic disinflation” might react to a favorable shock to supply or prices by lowering its medium-term objective for inflation (Orphanides and Wilcox, 2002). In the case of a central bank pursuing such a strategy, foreign factors that depress domestic inflation may have a persistent effect so long as inflation exceeds the central bank’s long-term objective.

With respect to the strength of our responses to output gaps and inflation gaps, I think the Committee hasn’t been as gradual or as damped in its responses as the equations say it has. In my view there are a couple of points indicative of biases there. One is that the Committee has been forward-looking, so we’re really looking at forecasts and not at existing output gaps. We can often bring information to bear that says that a particular shock will likely go away and we don’t need to react so strongly to it.

So I think the wrong stuff is on the right-hand side of these Taylor rules; the Committee is doing much more than looking at the current levels of those two gaps. The second point is that these estimates are made on the assumption of a constant inflation target, in this case from 1987 through the present. I don’t want to get into a discussion of whether it should or should not have been constant. But I do believe that, from 1987 at least into the second part of the 1990s, the Committee surely did not have a constant inflation target. A number of the former members of this Committee talked about an opportunistic approach to reducing inflation. Inflation was higher than it needed to be over the long run, but there wasn’t any extraordinary effort to reduce it. The models wanted us to be stronger in reducing inflation because they had a lower inflation target than the Committee and the Committee didn’t react to the model’s target but to its own. I think that biases the results to finding that the Committee didn’t act as aggressively as the models thought it should, when in fact it acted fairly aggressively—and aggressively enough to get some pretty darn good outcomes for the economy over the past twenty years.

Having said that, I think there is a valuable lesson embedded here, and it goes to the discussion you were having about policy mistakes. It’s better generally for policy to act too strongly than too weakly to developing situations. Serious policy errors have been made when policy doesn’t react aggressively enough to a developing situation. Examples are the Federal Reserve in the 1970s or the Bank of Japan in the 1990s.

That is the sort of policy error that allows expectations to get out in front. It allows a spiral to develop that becomes very, very hard to reverse. If we react too aggressively, that also can be a policy mistake. But tightening too much because we’re afraid of inflation or easing too much because we’re concerned about deflation or recession is much more easily reversed without cumulating expectational problems getting built in. So to me the lesson for the Committee from these optimal rules is that we are probably better off being a little too aggressive than being not aggressive enough in terms of the possible consequences for the economy over time.

A couple of years ago, I gave the name "opportunistic disinflation" to an alternative strategy for bridging between short-run policy and long-run goals, a strategy that I observed the Federal Reserve to be following at the time. I will use this strategy this evening to describe my own position. But I want to make clear that I am not speaking for others on the FOMC or describing official policy. Under this strategy, once inflation becomes modest, as today, Federal Reserve policy in the near term focuses on sustaining trend growth at full employment at the prevailing inflation rate. At this point the short-run priorities are twofold: sustaining the expansion and preventing an acceleration of inflation. This is, nevertheless, a strategy for disinflation because it takes advantage of the opportunity of inevitable recessions and potential positive supply shocks to ratchet down inflation over time. Proponents of this strategy sometimes describe this approach as reducing inflation cycle-to-cycle or describe the economy as being one recession from price stability. Under this strategy, if growth were to slow to trend, the unemployment rate were to remain where it is, and inflation were to remain stable, monetary policy would remain on hold, ready to respond aggressively to any acceleration of inflation, but otherwise prepared to be patient and accept the lower inflation that will accompany the next recession or favorable supply shock.

In the last several years, a number of current and former members of the Federal Open Market Committee (FOMC) have developed a new view as to how the Federal Reserve should close the gap between the current rate of inflation and the long-run objective of price stability. Proponents of this new view hold that when inflation is moderate but still above the long-run objective|as is the case currently|the Federal Reserve should not take deliberate action to reduce inflation. Instead, it should wait for external circumstances|e.g., favorable supply shocks and unforeseen recessions|to deliver the desired additional reduction in inflation. Until such disinflationary shocks occur, the Fed should move aggressively to counteract incipient increases in inflation...

This approach to the conduct of monetary policy has come to be known as "the opportunistic approach to disinflation."

From The Opportunistic Approach to Disinflation by Athanasios Orphanides and David Wilcox