I think this edit is a fair summary of the post.
People sometimes characterize me as thinking that more inflation would help the American economy. I think it might, perhaps, within limits. But what I really think is that more tolerance of inflation would help the economy, not the inflation itself.
It's not that three or four percent inflation is such a wonderful goal. It's that extreme aversion to three or four percent inflation is causing the Federal Reserve to persistently "shoot too low" in terms of aggregate demand.
I don't know about you, but I think that, so long as Congress blocks fiscal stimulus, the USA needs higher inflation or expected inflation. I think it would be OK if people expected that inflation would be high in 2018 or so, then changed their minds in 2014 (so inflation was never far below the level expected when 3 year contracts were negotiated). In that case (and the arithmetic is tight) I think high expected inflation without high actual inflation ever would be OK.
But seriously, I think we need either fiscal stimulus or higher inflation to avoid horrible unemployment and lost output .
I have long ago noticed that I very much disagree with you about monetary policy. But only now do I realize how absolute and profound our utter disagreement is. Basically, you think that at the current zero bound, the Fed can stimulate aggregate demand through some channel other than expected inflation or actual inflation.
My sense is that very very few economists agree with you. Scott Sumner does. Uh there may be others.
How exactly is it supposed to work ? Your post assumes that the Fed can pull aggregate demand up just as an archer can point the bow and arrow up. But if you don't just assume that but rather attempt to explain it, then how does it work with a Federal Funds rate of zero and no increase in inflation or expected inflation ?
This comment is very late, because, after reading the first two paragraphs I feared my head would explode if I read the rest. I'm glad to say that didn't happen.
I think that you are important enough on the blogosphere that say Paul Krugman would be willing to discuss the question with you. Why don't you ask him to do that ? I have a high opinion of your intellect and I find it quite painful to read your posts on monetary policy. So what I don't have to read your blog and you owe me nothing. But please.