P248 inflation targeting(2)

Is inflation targeting dead? Central Banking After the CrisisIn the case of the Eurozone, where the debt problem of the periphery is likely to last,this credit risk on the ECB’s balance sheet may eventually require printing money andgenerating inflation. With or without inflation the situation is one in which the centralbank does not act independently and may lose that credibility, which is its fundamentalanchor.In such cases, a better alternative would be to explicitly recognise the fundamentalconnection between fiscal and monetary policy which is deliberately obscured innormal times but which surfaces when the economy faces a debt problem. This requireseither tolerating higher inflation temporarily by redefining the notion of medium termin a very flexible interpretation of inflation targeting, or redefining the target and thecommunication associated with the policy designed to achieve it as recently done bythe Federal Reserve (a version of this policy would be nominal GDP targeting). Theessential goal is to preserve the anchor and the independence of the central bank to acteven in recognition of the fiscal implications of its policies, not to preserve inflationtargeting as we have known it in normal times. However, a key challenge in suchsituations is not to kill the incentives for governments to act on solvency issues.ReferencesLenza, M, H Pill and L Reichlin (2010), “Monetary policy in exceptional times”,Economic Policy 25, 295-339.Giannone, D, Lenza, M Pill and L Reichlin (2012), “The ECB and the interbankmarket”, The Economic Journal, forthcoming.Giannone, D, Lenza, M and Reichlin, L (2013), “Money, credit, monetary policy andthe business cycle: has anything changed since the crisis?”, London Business School,January, mimeo.138