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

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Challenges to inflation targetingafter the CrisisLucrezia ReichlinLondon Business School and CEPRThe financial Crisis and the exceptional policies that central banks have used presentinflation targeting with several challenges. This column discusses these challenges,arguing that by blurring the distinction between monetary and fiscal policy, centralbanks’ independence, and thereby the principle of inflation targeting, has beencompromised. By losing independence, central banks may lose credibility and thereforetheir anchor. There is thus a case for either redefining inflation targeting or changingthe framework entirely.The key idea of inflation targeting is public commitment to a fixed numerical targetfor inflation in the medium term. Commitment to such a target is consistent with manydifferent paths of real and nominal variables and is consistent with policies which, in theshort run, aim at stabilising output exploiting the inflation/output trade-off. In its broaddefinition, inflation targeting leaves room for much flexibility but, whatever the actualimplementation and interpretation, the framework is intimately linked to the principleof central-bank independence. It is because they have to protect their independencethat unelected central bankers need to act according to a clear mandate and followa quantifiable and publicly announced target. This makes them accountable. Withoutaccountability and transparent communication, independence would be hard to justifyand would most likely be challenged.Another characteristic of inflation targeting is separation between monetary policyand fiscal- and financial-stability objectives. However, while the separation fromfiscal policy is an essential ingredient of independence and is therefore essential to theframework, it is less clear that the separation from financial stability is essential, as it134
Challenges to inflation targeting after the crisisrelates to the technical issue of the need for different instruments to deal with differentobjectives. An inflation-targeting central bank, provided that it acts independently,can use instruments other than the short-term interest rate to pursue financial-stabilityobjectives that are not in contradiction with the inflation-target mandate.In my view, the question of whether the Crisis has led to a challenge to inflation targetingis not the technical question of whether central banks can/should successfully pursuefinancial-stability goals as well as monetary-policy objectives if given additional toolsthan interest-rate setting. Rather, it is whether the types of policies which need to bepursued in prolonged periods of financial distress in order to stabilise economic activityproduce ‘collateral damage’ which, essentially, puts at risk the principle of central-bankindependence.A challenge to central-bank independenceThe financial Crisis and the exceptional policies which central banks have implementedto deal with it, by blurring the distinction between monetary and fiscal policy, haveindeed challenged central banks’ independence, and thereby the principle of inflationtargeting. This is the most complex issue we face today when rethinking monetarypolicy. By losing independence, the central bank may lose credibility and thereforeits anchor. In such a situation there is a case for either redefining inflation targeting orchanging the framework.This problem is perhaps more obvious in the case of the Eurozone. As a response tothe banking crisis following Lehman, the ECB introduced the Long Term RefinancingOperations through which liquidity was provided to banks at satiation at a fixed rate andfor up to one year. In 2012, the horizon of the Long Term Refinancing Operations wasextended to up to three years. In a way this policy can be understood as the textbookreaction to a liquidity crisis: facing a drying up of liquidity, the central bank steps in byproviding it in unlimited quantity against collateral. Aggressive action by the ECB tofacilitate banks’ funding is likely to have had a decisive role in preventing a meltdown135
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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? Centra
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The evolution of modern centralbank
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Inflation targeting: Fix it, don’
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Is inflation targeting dead? Central Banking After the Crisis - Vox

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