The 2% inflation target and should it be higher

There is again talk that the 2% inflation target that is used by many developed countries is too low. Of course, we have not hit that 2% target and inflation has generally been moving away from the target, but now some central bankers think it should be raised to say 4%. This is a topic that has been floating around for years starting with IMF chief economist Olivier Blanchard in a provocative research paper.

This is all about central bank creditability. In the 70's, central banks lost all creditability as inflation fighters. It took the Fed's Paul Volcker to push rates to unprecedented levels to break inflation expectations. The 1990's heralded the period of inflation targeting with the level almost universally set at 2%. Central banks were able to reach their goals during a period of macro calm, the Great Moderation. The markets believed that central banks could and would hit the 2% target. 

Now, central banks think they have done too good of a job and they  need to get inflation expectations to a higher level. With higher expectations, the real rate can be pushed lower which is what the central banks want. By forcing real rates down to the equilibrium rate or below, the monetary authority could stimulate growth. of course this assumes that nominal rates do not increase in lockstep with the increases in inflation. 

This is all nice in theory, but do we want a breakdown in central bank creditability and do we want to actually face inflation significantly above 2%? If this high inflation view became the policy of the land, fixed income markets will be in a world of hurt.