In his latest post Tim Duy ends thus:
Ultimately, I think the Federal Reserve made a huge policy error in committing to an explicit 2% inflation target. I think policymakers were under the impression that such a commitment would give them more flexibility by removing concerns that QE would be inflationary. In reality, I think it had the opposite effect – it eliminated a policy tool, thereby reducing their flexibility. And that commitment stands as a barrier to Evans’ suggested policy path. I think the rest of the Fed would loathe accepting inflation as high as 3% given they just committed to 2% at the beginning of this year. In doubt, they would view such backtracking as a threat to their much-cherished credibility.
Interestingly, they don’t see Treasury rates below 1.4% as a threat to their credibility. They really should.
I thought so the moment the target was made official (here). The fact is that Bernanke has made one bad move after another, but keeps saying “there´s a lot more the Fed can do” (if only things get worse)!
Thirty years ago the Volcker´s Fed took drastic action to bring inflation down. At the time the real economy suffered – RGDP fell and unemployment soared – because inflation expectations were entrenched, i.e. the Fed had little credibility. But note from the chart that once Volcker showed he meant “business” inflation expectations rolled down even while nominal spending was rising fast to get the economy on track. And soon the economy was back to “potential”. Nothing of the sort, aside from falling inflation expectations, is happening now. The 2% target is really a formidable barrier!