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

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Is inflation targeting dead? Central Banking After the CrisisRefining inflation-targeting frameworksPrice stability was clearly not enough to deliver financial stability. This raises twoseparate challenges for inflation-targeting regimes. First, it is essential that we integratefinancial-stability considerations into inflation-targeting frameworks. The build-upof financial imbalances before the financial Crisis occurred during a period of lowand stable inflation (see centre panel of Figure 1). There are two ways to interpretthis observation. One is that inflation targeting in its prevailing form, with a pointinflation target to be met over a specified time horizon of a year or two, preventedcentral banks from leaning more aggressively against these imbalances. With broaderand more flexible mandates, ones that went beyond narrowly defined inflation targets,central banks would have maintained a tighter monetary-policy stance to curb thebuild-up of leverage and the underpricing of risk. An alternative view is that centralbanks simply lacked the tools they needed to mitigate financial-stability risks at a timewhen policymakers were pursuing price stability. Interest-rate increases high enough toeffectively mitigate pre-Crisis debt-fuelled property booms would also have caused amajor economic contraction. Some other tools, ones more appropriate to moderating thefinancial cycle – such as countercyclical capital requirements on lenders or maximumloan-to-value ratios applied to borrowers – are needed for times like this.Inflation-targeting regimes face a second challenge: a mechanism capable of providingmonetary stimulus even when the nominal interest rate hits zero. The severity of thefinancial Crisis and the recession that followed quickly drove policy rates to zero. Thedesire to provide further monetary stimulus has led to a number of innovations in theform of what are now commonly referred to as ‘unconventional’ policies. However,some have questioned the effectiveness of these tools in the light of the observation thatoutput in many economies remains well below the level implied by an extrapolationof the pre-Crisis trend. Because central banks are expected to tighten once inflationmoves above the target, inflation targeting is seen as standing in the way of a credible116
Flexible inflation targeting: Performance and challengescommitment to monetary stimulus that would return these Crisis-ravaged economies tolower levels of unemployment.More flexible inflation-targeting frameworksCan these challenges be addressed within the inflation-targeting paradigm? Webelieve that, by enhancing the flexibility of inflation-targeting frameworks along twodimensions, they can.• First, policymakers need more short-term flexibility in the pursuit of inflation targets.There is a need to lengthen the policy horizon beyond the conventional two years or sothat is typical of many inflation-targeting frameworks. And, we recommend specifyinginflation targets in terms of a range rather than setting a fixed value. These changeswould enhance central banks’ ability to lean against the wind of asset-price bubbles andto provide post-Crisis monetary stimulus while preserving the main benefits of inflationtargeting (in particular, the anchoring of long-term inflation expectations).• Second, central banks need to continue developing and refining new policy instruments.The pre-Crisis consensus was that monetary policy should be both framed andimplemented by manipulating short-term interest rates. The thinking was that, bytargeting and stabilising short-term interest rates instead of other intermediate financialvariables, policy would insulate the real economy from financial-sector shocks.However, the financial Crisis showed that the financial sector is connected to the realeconomy through a variety of channels, many of which are only loosely tied to the levelof short-term interest rates. Moreover, shocks from the financial sector could be solarge that policy rates reach their lower bound, preventing their further use in stabilisingaggregate demand. In response, policymakers have resorted to new types of instrument,as a supplement to policy rates. The size and composition of central-bank balance sheetshave been used to target both the level and slope of the term structure of interest rates.117
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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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Introduction• Consideration of su
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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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Is inflation targeting passé?In su
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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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