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

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Is inflation targeting dead? Central Banking After the Crisistypically insensitive to interest-rate policies since agents are engaged in repairing theirbalance-sheets through deleveraging.In contrast to the near universal embrace of macroprudential polices, central banksreacted very differently to the lack of stimulus – there has been much experimentation.Different policies have been tried:• Balance sheet operations• Forward guidance, and• Changing targets.The first set of policies was quantitative and credit easing. These employed the size andcomposition central banks’ balance sheets in novel ways – pushing investors into riskierassets. Different justifications have been given for these policies: affecting long-terminterest rates, ‘market making’, or providing simulative wealth effects and releasing‘animal spirits’. A frequent target was the level and slope of the yield curve, althoughthe Fed also targeted specific market segments, such as mortgage-linked securities.Broken transmission mechanism and OMT: New goal and new toolsIn the Eurozone, the ECB implemented its version of credit easing by providing unlimitedliquidity at a fixed rate to financial institutions. But the Eurozone faces a challenge thatis unique among central banks – breakdown of the transmission mechanism within thecurrency area. In normal times, ECB interest-rate decisions are transmitted uniformlyaround the Eurozone. An interest-rate cut lowers the cost of capital to all euro users– banks, firms and governments in every EZ nation. An interest-rate rise does theopposite. Since the Eurozone Crisis exploded in May 2010, EZ financial markets havefragmented along national lines. A single policy rate set in Frankfurt translates intodifferent costs of borrowing across the Eurozone. Businesses in Spain and Italy, forinstance, pay more to borrow euros than businesses in Germany and Finland do.16
IntroductionThis posed a novel problem for the ECB. How can a monetary authority crediblycommit to keeping inflation stable when its policy rate is transmitted differently acrossthe currency area? A partial solution was found by inventing a new goal and a new tool.• New goal: As ECB President Draghi put it: “Within our mandate, the ECB is readyto do whatever it takes to preserve the euro.”The thinking was that breakup risk was an important cause of the fragmentation.• New tool: ‘Outright Monetary Transactions’ (OMT).OMT should be thought of as one of the new balance-sheet tools. Although it has notyet been tried, the idea is that the ECB will promise to buy unlimited amounts of an EZgovernment’s debt to maintain the ‘singleness of monetary policy’. To qualify for thistreatment, the EZ government must have asked for a bailout package. This ensures thatthe government cannot use the ECB’s action to delay its own necessary reforms.Other reactions to the loss of stabilisation power involve attempts to manipulateexpectations.Manipulating expectationsOne theory for why monetary policy lost its power turns on expectations. Investment –the traditional driver of recoveries – depends upon expectations of real interest rates andfuture growth. The thinking is that investors might be failing to invest since they fearthe central bank will take away the punchbowl just when the economy starts to swing.Manipulating expectations are a way of assuring investors that this won’t happentoo soon. These new tools are aimed at expectations of: i) future interest-rate policy,ii) future growth, iii) and/or future inflation. For example, in 2012, the Fed stated it“currently anticipates that exceptionally low levels for the federal funds rate are likelyto be warranted at least through mid-2015”.One version is called ‘forward guidance’. The intellectual father of forward guidance,Michael Woodford, points out that many interest-rate paths will take an economy from17
Page 1: Is Inflation Targeting Dead?Central
Page 5 and 6: ContentsForewordviiIntroduction 10L
Page 7 and 8: ForewordSince the onset of the Glob
Page 9 and 10: ForewordThe limits of monetary poli
Page 11 and 12: Introduction• Perpetrator: Inflat
Page 13 and 14: Introductionboth transparent commun
Page 15: Introduction• Financial crises of
Page 19 and 20: Introductionuntil unemployment fell
Page 21 and 22: Introductionbalance-sheet impairmen
Page 23 and 24: Introduction• Consideration of su
Page 25 and 26: Introductionenhance actual growth,
Page 27 and 28: Introductionrather than interpretin
Page 29 and 30: IntroductionConcluding remarksInfla
Page 31 and 32: Who killed the inflation target?Lor
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Page 37 and 38: Is inflation targeting passé?Stefa
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Page 44 and 45: Monetary targetry: Might Carneymake
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The evolution of modern centralbank
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Is inflation targeting dead? Centra
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Inflation targeting: Fix it, don’
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Nominal-GDP targets, without losing
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A broader mandate: Why inflationtar
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Will central banking change?Charles
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Central banking after the Crisis:Ch
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Challenges to inflation targeting a
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Is inflation targeting dead? Central Banking After the Crisis - Vox

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