Last month, financial market developments appeared to be dizzy. Shanghai crash, international contagions, the overall tenor of portfolio risk adjusments, subprime-mortgage meltdown, downward risks of economic outlook with still strong inflation developments. In summary: Uncertainty is back. Last wednesday Bernanke did the right thing, removing the tightening bias in FOMC statements. This action stabilized markets at least to a marginal degree.
However, Bernanke and his colleagues fueled the uncertainty machine even more. They missed to make clear the following critical points. Economic outlook and inflation objective. Especially Board member Mishkin confused markets when he commented last Friday that a reduction of core inflation below 2 per cent might be too costly. Immediately, markets started speculating about the "real" inflation objective.
As we all know, maintining credibility by means of achieving the inflation objective is essential to get inflation expectations well anchored.
