The Fed could raise
inflation either by increasing demand, higher demand would increase the
price-level, or reduce supply, lower supply would increase prices, relative to
each other. Demand-side would work when employment and real wages would go up
and supply-side would work for inflation targeting if supply goes down. Both,
together, mean that demand should go up in comparison to supply, i.e., demand
should go up relative to supply or supply should go down. Moreover, low prices
and expectations show that supply is abundant and demand is low. In this
situation inflation targeting would lower real wages and demand, supply would
outpace demand, prices further would go down. On the opposite, if we lower
inflation expectation, lose money-supply would also increase real wage
expectations which means more spending and less wage demand due to lower prices
could also increase export competitiveness. If prices would fall it would do
the both increase demand and also reduce some supply due to lower prices which
might help the inflation targeting. However, if the Fed tries to increase
inflation by inflation targeting it would reduce real wages expectations and
demand and spending and higher prices would further improve supply in the event
of low demand and lower prices could fail inflation targeting. Higher inflation
expectations would not let inflation targeting work because demand would go
down and supply would increase means lower prices, however lower inflation
expectations might increase inflation in the future by increasing real wages
demand and limiting supply due to low prices...
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