Fed Must Set Explicit Inflation Target

The President of the Cleveland Federal Reserve--Sandra Pianalto--argued that the Federal Reserve must set an explicit inflation target in an essay released Tuesday, according to ForexLive. Though Pianalto is not a voting member of the Federal Open Market Committee at the present time, (those positions rotate yearly) her argument could influence future Fed policy. Her idea is to have the Fed set an explicit inflation target rate of 2% per year and only allow inflation to deviate from the 2% goal when economic shocks require it. Even then, she states that the Fed must work to get inflation back to 2% in two to four years following a shock. The purpose behind the explicit inflation target would be to keep future inflation expectations in check. Even if inflation is low, should firms believe that inflation will be higher in the future, they could raise prices to offset the future inflation. Those price increases would act as a self-fulfilling prophecy, effectively creating the inflation the firms anticipated. With unemployment remaining persistently high and concerns in Europe dampening the prospects of the global economy, inflation expectations might reasonably be assumed to be low. However, rising commodity prices and an expanding Federal balance sheet may suggest that high inflation is just around the corner. Keeping a tight leash on inflation may work in favor of the U.S. dollar. Traders looking to play a strong dollar may consider PowerShares DB US Dollar Bullish Index UUP. UUP tries to return a value corresponding to the value of the U.S. dollar.