Makeup Strategy in Monetary Policy

A makeup strategy in monetary policy is a commitment by a central bank to compensate for past overshoots or undershoots of its inflation or output target. Rather than reverting to the target immediately after a miss, the central bank tolerates an offsetting move in the opposite direction. This creates a “period-average” framework that prioritizes long-run stability over hitting the target every period.

The Problem It Solves

Standard inflation targeting asks the central bank to keep inflation at a fixed target (e.g., 2%) every period. This works smoothly in an ideal world, but in practice, inflation misses happen: supply shocks, demand surprises, measurement lag, transmission delays. When inflation undershoots for several years (as happened post-2008 financial crisis and into the 2010s), a strict inflation-targeting central bank is viewed as having failed—and loses credibility.

Makeup strategy flips the framing. If inflation undershot the target by, say, 0.5 percentage point per year for five years, the central bank now owes an 2.5 percentage point cumulative overshoot to return inflation to the trend it should have followed. By explicitly tolerating this makeup inflation, the central bank signals that it is committed to the long-run level of prices, not just the near-term rate. This commitment can anchor inflation expectations—a key asset for monetary policy.

Makeup Strategy vs. Pure Inflation Targeting

Pure inflation targeting (also called “hit-the-target-every-period”) aims to keep inflation at the target in each time period independently. If inflation overshot last year, policy immediately tightens to bring it back. If it undershot, policy immediately eases. This approach is simple and transparent.

The drawback is rigidity. It can create unnecessary volatility in output and employment as the central bank chases near-term inflation misses. It also undermines credibility: if the central bank claims inflation will average 2% over five years but then fights to hit 2% in every single quarter, and fails due to shocks, the central bank looks incompetent. Markets may lose faith in the target.

A makeup strategy trades near-term precision for long-run consistency. The central bank accepts that inflation will miss the target for a while, but commits to overshoot later to make up the cumulative miss. This smooths the path of inflation (reducing volatility) and anchors expectations on the long-run target level, even if near-term rates drift.

Makeup Strategy vs. Flexible Average Inflation Targeting (FAIT)

The U.S. Federal Reserve formalized makeup strategy as part of its Flexible Average Inflation Targeting (FAIT) framework in August 2020. Under FAIT, the Fed aims for inflation to average 2% over a sufficiently long time horizon—often left undefined to preserve flexibility. If inflation has been below 2% for several years, the Fed will tolerate above-2% inflation for a time to bring the average back up.

The key difference from pure makeup strategy: FAIT does not specify exactly how much makeup is required or over what period. It is more flexible. Pure makeup strategy can be mechanical: if you missed by X, you overshoot by X. FAIT is vaguer: inflation averaging “sufficiently” close to 2% over a “sufficiently long” horizon, with the Fed retaining discretion.

This flexibility has tradeoffs. It gives the central bank room to respond to new information and changing conditions. But it also opens the door to criticism that the Fed is not truly committed to a rule—it is just using makeup language to justify whatever policy it wants.

Makeup Strategy vs. Price-Level Targeting

Another related framework is pure price-level targeting, where the central bank aims for the price level to follow a set path (growing at a constant rate, say 2% per year). If inflation undershoots and the price level falls behind the target path, the central bank commits to overshooting inflation until the price level catches up.

Pure price-level targeting is a stricter version of makeup strategy. Under price-level targeting, the makeup is mechanical and total: the price level must return to its target path, no matter what. Under makeup strategy in practice, the central bank has discretion over the pace and size of makeup.

The Federal Reserve’s 2020 FAIT framework incorporates makeup logic without embracing pure price-level targeting. This middle ground gives credibility from the makeup commitment while preserving flexibility.

Why Central Banks Adopt Makeup Strategy

Credibility and expectation anchoring: When the central bank promises makeup, it signals that it cares about the long-run target level, not just short-term hitting. This can keep inflation expectations anchored even when current inflation drifts.

Reduced output volatility: If the central bank is less aggressive about returning inflation to the target every quarter, it can tolerate some slack in the labor market and spare the economy unnecessary contraction. Makeup strategy allows a smoother output path.

Forward guidance: By committing to makeup, the central bank gives markets and the public a clearer picture of future policy. If inflation just undershot, forward guidance that says “we will be accommodative for a while” is more credible if the public knows the Fed is committed to making up the miss.

Post-crisis recovery: The Federal Reserve adopted FAIT in 2020 partly because it wanted to support employment recovery after COVID-19 without being accused of abandoning its inflation target. By framing policy as FAIT with makeup, the Fed could maintain aggressive accommodation while still appearing committed to price stability.

Practical Mechanics: An Example

Suppose the Fed’s target is 2% inflation per year. From 2015 to 2019, inflation averages 1.5% per year—an undershoot of 0.5 percentage points per year. Over five years, the cumulative miss is 2.5 percentage points.

Under pure inflation targeting, once inflation returns to 2% in 2020, policy is back on track. The 2.5 percentage point cumulative miss is ignored.

Under makeup strategy, the Fed recognizes the 2.5 percentage point miss. If inflation averages 2% in 2020, the Fed will be accommodative in 2021–2022, accepting inflation of, say, 2.5% to 3% to make up the miss. Once the cumulative overshoot has offset the cumulative undershoot, the Fed reverts to neutral policy aimed at the 2% target going forward.

In practice, the makeup period can be quite long and the math is not mechanical. But the principle is the same: tolerance for above-target inflation when prior below-target periods occurred.

Criticisms and Risks

Inflation expectations de-anchoring: If the central bank talks about tolerating higher inflation later, the public might interpret this as actual commitment to higher average inflation, not just makeup. This could push inflation expectations upward permanently.

Time-consistency problem: Once the makeup period arrives, will the central bank actually stick to tolerating high inflation? Or will it abandon the strategy and tighten early? If markets doubt credibility, the makeup strategy loses its anchoring power.

Communication difficulty: Explaining makeup strategy to the public is harder than saying “we will keep inflation at 2%.” Vague language about “sufficiently long” periods and “sufficiently averaged” inflation invites skepticism.

Asymmetry: If the central bank undershoots one period and overshoots another, but they are of different magnitudes, which one do you make up for? This discretion can look arbitrary.

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