Explaining the Fed Credibility Argument
I think the credibility argument is really about the underlying motives of the policymakers, rather than their abilities. However I also think that argument is overdone – it takes a few generations to forget the lessons of the past, and policymakers are still obsessed with the 1970s.
In my words, two possibilites:
1. It’s a smokescreen. Actual reason: Creditors hate (unexpected) inflation. One extra percentage point transfers hundreds of billions of dollars of buying power from creditors to debtors, annually. ‘Nuf to get a fellow’s attention. The Fed is run by creditors.
2. (70s) They actually are worried — that the higher inflation target won’t work in goosing the economy or employment, so they’ll run into a stagflation situation where stomping on (spiraling?) inflation is…problematic. So they won’t be able to fulfill the second half of their promise without causing a job recession a la Volcker. Rock and a hard place.