"Losing its credibility as an inflation-fighter, some of it anyway, is precisely what the Fed needs to accomplish. As Paul Krugman has put it, the Fed needs to promise to be irresponsible at some future point, thereby raising expectations of future inflation. That, in turn, will boost current inflation. Consumers will want to spend their money in the period before its value erodes, and through that mechanism future inflation becomes current inflation.
So the question then becomes: can the Fed convince markets that it will be irresponsible in the future? The answer, quite obviously, is yes. The Onion helpfully suggested one way in which this might be accomplished. At a recent dinner, colleagues of mine joked about other ways to solve the problem. One suggested that Ben Bernanke might ask to have his salary indexed to gold or the Swiss franc. Another said the chairman should take to the podium to tell Americans they'd better start spending their dough soon before it's worthless, lighting a cigar with a $100 bill all the while. More practically, Mr Bernanke could raise his desired inflation target or simply declare that the Fed won't touch rates for a certain period, no matter what happens in the broader economy."
People, if the Fed has credibility as an inflation fighter it is for the Rogoffian reason that we have appointed inflation adverse central bankers. That is, people whose preference is for low inflation.
Please repeat after me:
THE FED HAS NO MECHANISM TO BIND ITSELF TO LIVE UP TO ANY ARBITRARY PROMISES IT MAY MAKE TODAY ABOUT THE FUTURE!!!
Promises to act against one's preferences in the future that are made without any commitment mechanism are simply cheap talk and are extremely unlikely to shape agent's expectations or actions.
We could appoint a central banker whose preference was for high inflation. In that case any promises to create low inflation or deflation in the future would be incredible and ineffective for exactly the same reason today's conservative central bankers' promises to create future inflation would be incredible and ineffective.
This is not a Tinkerbell situation folks; believing in magic is not going to get us through the crisis.