Inflation Targets: Cutsinger’s solution

Question: Some economists have argued that the Fed should raise its inflation target from 2 percent to 3 or even 4 percent. Why might the effect of a higher inflation target on the quantity of real money balances demanded be larger in the long run than in the short run?

Solution:

Economists often treat price theory and monetary theory as conceptually distinct. Milton Friedman, for example, called this the major division in economics. Monetary theory, he argued, concerns the overall...