Sorting through Mixed Signals to Find an Interest Rate Target
A central bank finds itself in the following situation: The national economy has been in a slump for several years, but recent signs of strength in much of the economy have led many forecasters to conclude that an expansion could finally be in the offing. Nevertheless, the unemployment rate is at its highest level in more than three decades, even though a recent increase in the price level may have signaled that inflation, which has been dormant for several years, could be about to take off again.
What factors indicate that the central bank should increase its target for the nominal interest rate? What factors indicate that it should reduce its interest rate target? What should the central bank do?