Ultimately, It's About the Inflation Target: Ryan Avent reports from Chicago on the willingness to believe the Fed is powerless to produce additional inflation:
Why is Mr Hall—why are so many economists—willing to conclude that the Fed is helpless rather than just excessively cautious? I don't get it; it seems to me that very smart economists have all but concluded that the Fed's unwillingness to allow inflation to rise is the primary cause of sustained, high unemployment. And yet...this is not the message resounding through macro sessions. Instead, there are interesting but perhaps irrelevant attempts to model the funny dynamics of a macro challenge that actually boils down to the political economy constraints (or intellectual constraints) facing the central bank. Let's focus our attention on that, for heaven's sake.
Avent is correct. It does seem that most economists believe that at the zero bound, allowing inflation expectations to rise is an effective - perhaps the only effective - mechanism for the central bank to accelerate activity.
Moreover, if, as Avent says, we believe the Fed can prevent deflationary expectations, then they can certainly create inflationary expectations. The fact that they don't would then be something of a mystery, as certainly we don't see Federal Reserve Chairman Ben Bernanke as intellectually deficient on this issue. He can clearly do the math as well as anyone….
The Fed has a dual mandate, and, according to its forecasts, it cannot meet both of the mandates in the near to medium terms under the expected policy path. So a choice needs to be made. And the Fed has chosen to focus on meeting the inflation side of the mandate…. No mystery. No reason for vast intellectual expenditures. Price stability means 2% inflation, and if we can't meet the unemployment target within that mandate, so be it…. 2% is a firm target, and the costs of exceeding that target, or, more importantly, changing that target, are effectively assumed to be infinite and thus by definition exceed any expected benefits….
There is a real question here that I don't believe the Fed has adequately answered - why should the definition of price stability be 2% rather than 3%? … [W]hat is the constraint - political, intellectual, or irrational - that forces the Fed to adopt a 2% inflation target, and then choose to act as if that target was written in stone?…
[If you] would argue that the economy would be less stable in the absence of a firm target… this might be correct for the eight decades a century that you are not in a liquidity trap, but what about the other two decades you are?…
Core inflation has clearly been rapidly decelerating…. If you believe, as the Fed appears to, that core-inflation provides useful information on the direction of headline inflation, then the message is clear - headline inflation is likely to drift lower, and the economy needs more stimulus. What the Fed will deliver, however, will still be within the bounds of the 2% inflation target, and thus still falls short of the increase in expected inflation that the Fed should really be delivering.