Inflation+Targeting

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Question
Should the Fed, in increasing transparency, adopt an explicit inflation target?

Background
When businesses make investments or plan for the future, they inevitably must form inflation expectations. Inflation in the future can have great influence on interest rates (real interest = nominal interest - inflation), so any prudent investor must adjust for expected inflation in order to make a profit on an investment.

To illustrate this, consider a business that has $1 billion that it wants to invest in the bond market. It buys 1,000 10-year US Treasury Bonds, each with a face value of $1,000 and a coupon rate of 5%. That means that every year the government pays the holders $50 each year and, at the end of the 10 years (when the bond matures), the government pays back the full $1,000 and the business nets $1,500 for a total of $1,500,000.

In good times, this is a pretty sound investment. Inflation, however, can wreak havoc with this. Imagine now that there is high inflation for the next 10 years. The business gets the $1,500 as promised, but when it gets it, that money has only a real value of, say, $900: a bad investment (the "real value" is a way of indicating the bond's worth after factoring inflation. It's basically how much $1,500 would have been able to buy today.  That is to say, if inflation caused prices to double, we could say that the $1,500 is only worth a real value of $750).

In order to prevent this from happening, interest rates are usually adjusted for inflation. Thus, if we expect 2% inflation for the next 10 years, we would demand a 7% interest rate in order to get a real return of 5%.

Unfortunately, inflation usually acts contrary to expectations. Businesses, in order to adjust for this risk, thus look for even higher interest rates. Higher interest rates, however, are painful for borrowers. Thus, some call for the Fed to specify explicit inflation targets (so they'd effectively say, "we're keeping interest rates at 2%") to keep uncertainty at a minimum.

Importance
(what this means for Fed Challenge members)

There is an ongoing debate in the Fed about whether the Fed should adopt an explicit inflation target. Chairman Bernanke in particular is in favor of it, but because of the reasons noted above, the Fed has been hesitant to adhere to an exact target. Instead, they have adopted a target "range" which they believe to be a comfortable rate of inflation in keeping with their dual mandate of //price stability// and full employment. Knowledge of the arguments within the discussion are essential for Q&A.