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

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Is inflation targeting dead? Central Banking After the CrisisCharles Wyplosz writes: “The next challenge will occur when the time comes to exitnonstandard policies.” Inflation targeting, he figures, will issue timely signals that ‘exittime’ has come. But no central bank has clarified its exit strategy. The key issues willbe the choice of instruments to absorb liquidity, and ways of communicating intentions.For example, if politically intractable debt problems require central banks to toleratehigher inflation temporarily, attempting to hide this may backfire. A better alternativemight be to explicitly recognise the fundamental connection between fiscal andmonetary policy, but redefine the target and the communication to preserve the anchorand the independence of the central bank. More coordination between monetary andfiscal policy should be considered but then the institutional framework which hasgoverned the relation between central banks and governments may need to be revised.This may be part of the exit strategy and it is particularly important for the Eurozonewhere the key challenge will be to avoid letting governments win the game of chicken.Lorenzo Bini Smaghi’s experience on the ECB Executive Board leads him to sound thealarm on such possibilities. “Such central bank action would ease the pressure on thegovernments“. He writes: “Politicians would certainly appreciate this, but for society,the advantages are a lot less clear. … Pursuing this approach further could lead to aneven greater crisis.” Exit strategies are an important topic for future research, but itshould come soon. The longer central-bank activism lasts, the harder it will be to end.Stop looking to SupermanCentral banks have had a ‘good Crisis’, so to speak, especially relative to politicalleaders. This may have raised expectations to unrealistic levels. The slow recovery isseen by many as a central bank policy failure. Many of our authors viewed this asmistaken.Central banks are being asked to take on tasks more properly done by governments.The public should recognise that there are limits to monetary policy. For example,26
Introductionrather than interpreting the slow recovery as a failure of monetary policy, it may simplyindicate that the magnitude of the shock has exhausted the capability of monetarypolicy to stimulate demand. Growth also requires structural reforms in the labour,goods and capital markets as well as bank recapitalisations. These are the responsibilityof governments, parliaments and regulators.Bottom line: Inflation targeting, refined not replacedWe started our introduction by asking whether inflation targeting is dead. In a narrowsense, the answer’s obvious – it’s been dead since central bankers started innovatingin 2008. Central bankers dealt with the Crisis by developing new tools and, at least insome cases, putting more emphasis on growth and financial stability. The emphasis ongrowth comes to the realisation that inflation stabilisation is not associated with outputstabilisation in the short run, and the short run may last for quite a while in economieswhich are dealing with a debt problem.Notice however that inflation targeters were never indifferent to growth. Growth andjobs mattered only to the extent that a commitment to a medium-term objective in termsof inflation remains credible. While this is certainly still true in the rhetoric, some – theFed and Bank of Japan for example – seem to be shifting priorities. They increasinglyact as if nothing will work without a healthy economic recovery. This is what MohamedEl-Erian calls the ‘reverse Volker moment’, referring to Volker’s switch in the early1980s to an inflation-is-all-that-matters approach.In addition to the medium-run inflation target, central banks have implicitly or explicitlyembraced a second goal – financial stability. 7 With a second goal came different tools.Almost all central banks added macroprudential policies to their toolkit. Many alsostarted using their balance sheets in new ways. Not to create money as before, but toundertake ‘market making’ interventions in key financial-market segments. It remains7 In most nations, responsibility for the second goal is shared with regulatory authorities.27
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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 and 16: Introduction• Financial crises of
Page 17 and 18: IntroductionThis posed a novel prob
Page 19 and 20: Introductionuntil unemployment fell
Page 21 and 22: Introductionbalance-sheet impairmen
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Page 25: Introductionenhance actual growth,
Page 29 and 30: IntroductionConcluding remarksInfla
Page 31 and 32: Who killed the inflation target?Lor
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Page 66 and 67: The evolution of modern centralbank
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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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