Is inflation targeting dead? Central Banking After the Crisis - Vox

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A broader mandate: Why inflationtargeting is inadequateKarl WhelanUniversity College DublinThe Crisis has ruined inflation targeting’s ‘wonder drug’ reputation. This columnargues that central banks should have a broad mandate that incorporates financialstability, good macroeconomic performance, and a target for price stability that isconsistent – as far as possible – with their other goals. The elegant theories that showfixed rules to be best are intellectually attractive, but not particularly good guides toreal-world policymaking.Recent years have severely tested central bankers. In response to severe recessionsand financial crises, they have adopted policies that have fitted uneasily with inflationtargeting, the dominant policy framework for the last 20 years. This raises the question:Is the current period of central bank practice an anomaly, soon to be followed by areturn to normal service, or does the Crisis point towards the need to consider wholesalechanges to how central banks conduct their business?In this essay, I discuss the future of central banking by addressing questions relatedto financial stability, macroeconomic stability and price stability. Overall, I argue thatthe events of recent years combine with economic theory to make a case against pureinflation-targeting regimes.104
A broader mandate: Why inflation targeting is inadequateThe foundations of inflation targetingInflation-targeting regimes were built upon two key intellectual foundations.• The first was Friedman’s (1968) insight that there is no long-run trade-off betweeninflation and output.While a short-run trade-off may exist in which higher output can be obtained at theexpense of higher inflation, in the long run the level of output that will prevail should beindependent of inflation. Since inflation is unpopular and output is beyond their controlover the long run, this insight implied that central banks should focus on what they cancontrol – a low rate of inflation.• The second is the literature on dynamic inconsistency pioneered by Kydland andPrescott (1977), and further explored in relation to monetary policy by Barro andGordon (1983) and Rogoff (1985).This research pointed out that, because a short-term trade-off exists between output andinflation, the public may expect a central bank to occasionally ‘cheat’ an inflation targetto produce higher output. It argued for institutional structures that encouraged centralbanks to commit to a low inflation outcome in a way that will be accepted by the public.If this outcome is obtained, a central bank will not only achieve its long-run inflationtarget, but will also face a friendlier short-run trade-off as inflationary expectations tendto stay ‘anchored’ in response to shocks.Combined with the unsatisfactory stagflation experience of advanced economies in the1970s, this academic literature had a profound influence on central-banking practice.From the late 1980s onwards, there was a significant trend towards making centralbanks more independent, giving them explicit inflation targets and setting price stabilityas their primary legal goal. Central bankers themselves increasingly conformed toRogoff’s recommendation, taking turns to see who could come across as more hawkishon inflation and inflicting long, boring speeches about the endless benefits of pricestability on many a captive audience.105
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Is Inflation Targeting Dead?Central
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ContentsForewordviiIntroduction 10L
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ForewordSince the onset of the Glob
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ForewordThe limits of monetary poli
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Introduction• Perpetrator: Inflat
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Introductionboth transparent commun
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Introduction• Financial crises of
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IntroductionThis posed a novel prob
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Introductionuntil unemployment fell
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Introductionbalance-sheet impairmen
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Introductionenhance actual growth,
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Introductionrather than interpretin
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IntroductionConcluding remarksInfla
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Who killed the inflation target?Lor
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Who killed the inflation target?How
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Who killed the inflation target?red
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Is inflation targeting passé?Stefa
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Is inflation targeting passé?Raisi
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Monetary targetry: Might Carneymake
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Is inflation targeting dead? Central Banking After the Crisis - Vox

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