Trail Balloons For Higher Inflation Being Floated

As reported by the Wall Street Journal, and webbed by Yahoo! Finance, there have been two calls in the last week for the Fed to set a higher inflation target. The first was from IMF chief economist Olivier Blanchard; the second has come from head of the San Francisco Fed's research department, John Williams. Both proposals are presented as being theoretical in nature.

The given reason why the Fed should be targeting a 4% inflation rate is that it adds an extra cushion against deflation. There's only 2% difference between a 2% rate and a 0% rate; right below the latter comes deflation. The subsidiary reason should be a familiar one: inflation eats away at debt and benefits the debtor. Uncle Sam is, of course, a huge debtor.

The end of the article reports that Ben Bernanke has taken notice of those calls, although rejecting them:

Mr. Bernanke has acknowledged the allure of a higher inflation goal. In written answers to lawmakers in December, he said a higher inflation target could in theory make it possible for the Fed to push inflation-adjusted interest rates lower, stimulating borrowing and economic growth.

But the opposite could happen, too. The prospect of higher inflation could cause interest rates to shoot up and make the burden of future borrowing even heavier. This is a particular problem for countries, like the U.S., that issue a lot of short-term debt and for people with adjustable-rate mortgages.

Mr. Bernanke concluded he didn't want to mess with people's fragile expectations. He said switching to a higher target would risk causing "the public to lose confidence in the central bank's willingness to resist further upward shifts in inflation, and so undermine the effectiveness of monetary policy."

The top economist at the Atlana Fed has panned the idea in more explicit terms. It's making the rounds, but is still controversial.