Monetary policy: The mandate problem: Yesterday's policy announcement is a real puzzler if one assumes that the Fed is interested at all in full employment or macroeconomic stability. It makes perfect sense once one realises that the Fed is solely and entirely interested in price stability. When the Fed initiated QE2, it wasn't responding to high unemployment, which had been high for months on end. It was responding to a sustained drop in inflation expectations. A Fed interested in macroeconomic stability would not have allowed QE2 to end in June, as nominal growth was still below trend and unemployment remained high. But a Fed focused solely on price stability couldn't help but get nervous about upward movement in core inflation. And yesterday's policy announcement was far too timid to push nominal GDP growth back to trend. It was, however, perfectly tailored to arrest the sudden, precipitous decline in inflation expectations….
I think there's a good chance that future economists will look back on the choice to stick with price stability as the central bank's goal as a strange and counterproductive norm, in much the same way current economists marvel at the disastrous central bank policies of the past. For now, America seems to be stuck with a Fed that's content to keep the American economy bumping along in statis, falling ever farther behind potential growth, so long as inflation stays nicely contained between 1% and 2%. It will fall to some future Ben Bernanke to apologise for present mistakes.