If there is a shortage of money — a demand shortage — and prices are sticky (real cash balances don’t rise on their own), we resort to increasing the supply of money. But, some think that the process of manipulating the money supply is not always very straightforward. At one extreme, the zero lower bound, the conventional process by which monetary policy works is no longer available. This is because when non-money financial assets are earning zero interest, people will reorganize their portfolios to carry more cash, because other assets are no longer earning an adequate premium to compensate for their relative lack of liquidity.
One alternative, or “unconventional,” monetary policy is to target inflation expectations. The Federal Reserve can do this by someway persuading money-holders that the Fed is committing to some inflation rate. Inflation acts almost as a tax on holding money. If people expect the value of their money to fall by some amount (whatever rate of inflation they expect), this may induce them to exchange their dollars for other assets, whether financial or otherwise. In other words, inflation expectations reduces the demand for money, narrowing the demand shortage.
When the Fed originally began its quantitative easing program, there were a lot of people arguing that the end game would be very high inflation, or even hyperinflation. Many bloggers, such as Paul Krugman, have criticized these people heavily. Fed policy, at the lower zero bound, is not inflationary at all! But, isn’t this self defeating? Instead, Krugman, et. al., should flame the fires of inflation fear, letting inflationistas warn without opposition of the impending apocalyptic devaluation of the dollar. In fact, the Fed should hire inflationistas to write for them! That way, they’ll persuade the public and inflation expectations will go through the roof.