Via Calculated Risk, James Bullard is hinting that the Fed is going to let inflation slip a bit.
I take that to mean the Fed would support a policy that allowed core inflation to drift above 3% and that tolerated headline inflation of 5%. This is, in my view the right policy. A credible promise to be irresponsible will be key in keeping the American economy out of the doldrums.
However, I’d like to see the Fed be more explicit. I understand not wanting to nail down specific numbers should circumstances change. However, right now much of the public and indeed the financial community believes that the Fed is targeting core inflation at 2%. Failure to meet that perceived target is just as damaging.
Furthermore, increased uncertainty in fixed income markets, as participants try to guess the Fed’s new target is exactly what we don’t need. Setting a hard target and genuinely working to get there will help keep the markets settled.
On the political side there is of course risk. There will be accusations that the Fed is headed towards hyperinflation. I imagine a cable commentator or tow will bring up the Weimar Republic or Zimbabwe.
There is a lot of insane rhetoric floating around about the US either defaulting or attempting to inflate away its debt. Its hard for me to get my head around how otherwise analytically minded people could believe this.
Accepting that, however, the political risk of unexpected inflation is more severe. At the very least a well reasoned case for 5% inoculates you against some of the worst rhetoric – the notion that you have lost control.