What's the Scenario, Yo?

In July Krugman speculated:

Picture America in, oh, 2014: unemployment is still around 9 percent, prices are falling about 1 percent a year. Many economists might look at that situation and say, well, deflation is stable, not accelerating, so we must be at the natural rate of unemployment -- move along, folks, nothing to see here.

Today he blogs:

And this raises the specter what I think of as the price stability trap: suppose that it’s early 2012, the US unemployment rate is around 10 percent, and core inflation is running at 0.3 percent. The Fed should be moving heaven and earth to do something about the economy -- but what you see instead is many people at the Fed, especially at the regional banks, saying "Look, we don’t have actual deflation, or anyway not much, so we’re achieving price stability. What’s the problem?"

This isn't a gotcha. I like the way Krugman employs his blog to brainstorm and try out ideas.

I think guys like Hoenig will be saying unemployment isn't a problem, but hopefully the rest won't be. According to the FOMC's June minutes, their targets are:

In 2014 presumably they'd want unemployment to be at 5 to 5.3 percent not 9 percent and PCE inflation at 1.7 to 2 percent not -1 percent. In 2012 they're predicting unemployment of 7.1 to 7.5 not 10 percent and PCE inflation of 1.0 to 1.7 percent not .3 percent. So if they don't want the legitimacy of the institution to take another* major hit, they should move heaven and earth to hit those targets.

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* The housing bubble and Great Panic has cost the economy trillions of dollars thanks in part to Greenspan's misplaced faith in the magic of self-regulating free markets. That's trillions that could have used to pay down the national debt or it could have been invested in our childrens' future via education and cleantech spending.