Even as the global economy is witnessing a synchronized recovery, inflation in most parts of the developed world continues to undershoot the target. In the US, for instance, prices continue to remain soft despite the level of unemployment drifting to a near 17-year low.
Earlier this week, Federal Reserve chair Janet Yellen said that it can be dangerous if inflation drifts down and over time the central bank is not able to achieve the inflation target. One reason why it could be so is that it could start affecting expectations and make things more difficult for the central bank. The Fed is widely expected to raise policy rates in its December meeting.
Clearly, the Fed would not want to be in a situation where it raises rates at a faster pace and puts further pressure on prices. However, it will also want to avoid raising rates too slowly, which might result in inflation overshooting the target.
Financial markets will keenly watch how the most important central bank strikes the right policy balance in the coming months.
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