Greg Ip argued that a central bank that can cause firms and workers to expect 2 percent inflation they will set prices consistent with 2 percent inflation. And so, a central bank should target inflation.
So, during the Great Moderation, did central banks create inflation expectations of 2 percent and cause firms and workers to set prices and wages so that the inflation rate remained 2 percent?
While it could be worse, I suppose, this hardly looks like prices and wages being set so that inflation remains 2 percent. It looks like a great deal of variation.
On the other hand, in the Great Moderation, nominal GDP did remain very close to a stable growth path.
Not perfect, but pretty close. Since the Federal Reserve was not explicitly targeting nominal GDP, what does this have to do with expectations? If potential output is expected to grow 3 percent, then it will take 3 percent more nominal expenditure to purchase that extra output at constant prices. If the Fed wants 2 percent inflation, then for firms to charge 2 percent more for 3 percent more output, total spending must grow 5 percent. A 5 percent growth rate of nominal GDP is needed, and so, that is what should be expected. If the Fed is credible.