Interest rate policy works to sustain price stability by stabilizing production costs against shocks to current productivity and future income prospects. The Fed should publicly target core PCE inflation in a 1 to 2 percent range to improve short-run communications and lock in credibility for low inflation. To secure credibility against deflation, the Fed should arrange more fiscal support for monetary policy at the zero bound on nominal interest rates than is ordinarily granted by Congress and the Treasury. By featuring price-cost, employment, and output gap indicators more prominently in its communications, the Fed can clarify the potential for inflation or deflation and its intentions for dealing with these threats.
Amanda L. Kramer
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