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

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Is inflation targeting dead? Central Banking After the CrisisThinking about inflation and money differentlyThe analysis of inflation targeting is primarily based on the widely used ‘NewKeynesian’ framework; this stresses price and wage rigidity (e.g. Woodford 2003 orGali 2008). We propose a different framework – ‘The I-theory of money’, where ‘I’stands for intermediation (Brunnermeier and Sannikov 2012). This stresses financialfrictions instead of price and wage rigidities. As such, I-theory is better suited foranalysing connections among the three stability concepts (price, financial and debt).In this theory:• Financial frictions hinder funds from flowing freely from ‘cash-rich’ to ‘cashstrapped’sectors.Plainly, it matters who has the cash.• If the financial sector is undercapitalised, it cannot channel funds to the most productiveparts of the economy.In this case:• The distribution of wealth matters for credit and growth.An impaired balance sheet or debt overhang in a specific sector will inhibit economicgrowth.In this framework, a negative shock – say to productivity or GDP – is amplified byfinancial frictions. Bank equity declines if the shock produces losses on the asset side oftheir balance sheets. Banks will then try to sell assets to reduce their risk exposure. Theassets, however, can only be sold at a loss since buyers from other sectors value themless. Banks’ balance sheets deteriorate further from the fire-sale loss. Liquidity spiralsamplify losses on the asset side of the balance sheets.There is more. With lower asset values, banks also issue fewer liabilities – that is, theycreate less inside money. The money multiplier between inside money created by thefinancial sector and outside money (reserves, cash and other high-powered money)96
Reviving ‘money and banking’collapses. The overall reduction in the money supply causes deflationary pressure a laFisher (1933), which increases the real value of the banks’ liabilities.In short, banks are hit on both sides of their balance sheets:• On the asset side, by the liquidity spiral; and• On the liability side, by the deflationary spiral.An initial adverse shock is amplified, leading to potentially large wealth redistribution.This highlights the close connection between price and financial stability becausemoney is created to a large extent by private financial institutions.Can monetary policy mitigate these adverse effects?Monetary policy can work if it redistributes wealth in such a way that dampens theamplification effects. Here monetary policy is unclogging the system and restoring theflow of funds to productive parts in the economy.For example:• Cutting the short-term interest rate, can increase the value of long-term bonds, thusstabilising banks’ balance sheets.• Purchasing specific assets held by a sector with impaired balance sheets softensamplification for that sector.For example, purchases of mortgage-backed securities support real-estate prices,helping households who suffer from debt-overhang problems 2 .2 This measure is not very targeted as well capitalised households benefit from it too.97
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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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Page 90 and 91: Nominal-GDP targets, without losing
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Is inflation targeting dead? Central Banking After the Crisis - Vox

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