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

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Is inflation targeting dead? Central Banking After the CrisisWouldn’t an inflation target regime also address the Fisherdeflation spiral?Inflation target would work e.g. with liquidity provision. This way the money that hadbeen created by financial-sector lending (inside money) is replaced with central-bankcredits (outside money). However, since balance-sheet impairments of specific sectorsare not addressed, banks might simply park extra reserves with the central bank insteadof passing it to the productive cash-strapped sectors in the economy.Monetary policy could do a better job of restoring the credit flow by focusing the realproblem – the impaired balance sheets. By redistributing wealth, this counteracts theamplification coming from the liquidity and deflationary spiral.Optimal monetary policy with financial frictionsThe first step in identifying the optimal policy is to identify the sectors that suffer fromimpaired balance sheets and amplification effects. Even if the central bank can onlyresort to pure interest-rate policy, it will have to think beyond a simple Taylor rule. Ithas to identify the blockages.To see this consider an economy whose current interest rate is 2%.• If the banking sector is undercapitalised and a credit crunch is imminent, then thecentral bank could cut the short-term interest rate, say to 1%.This typically widens the term spread between the long-term interest rate and shortterminterest rate. Cutting the short-term interest rate therefore provides a ‘stealthrecapitalisation’ for banks and might be useful if their balance sheet needs to be repaired.• If the end-borrowers suffer from debt-overhang problems, e.g. households withmortgage debt, it is more important to bring down the long-run rate instead of wideningthe term spread.98
Reviving ‘money and banking’This calls for forward guidance, e.g. by announcing that the central bank will notincrease the interest rate beyond 2% for the next two years. Such a policy will narrowthe term spread, and may hurt the banks, but benefits end-borrowers. More targetedstill would be the purchase of mortgage-backed securities, as they directly stabilise thehousing market.But doesn’t this ex-post optimal redistributive monetary policy create ex-ante moralhazardproblems?Moral hazard and I-theory monetary policyEx-post (tail) insurance through monetary policy can indeed lead to additional risktaking, but the amount depends on the monetary-policy design. Consider two banks thatgrant mortgages during the housing-bubble phase. In addition to the mortgages, bothbanks also hold long-term bonds of a government that does not suffer from fiscal debtsustainability issues. Say, the first bank is more aggressive as it holds more mortgagesrelative to the second bank, which holds more long-term government debt. If it is knownthat in a downturn the central bank will purchase long-term bonds to push up theirprice and will not intervene in the mortgage market, then the more conservative bankwill benefit more from the redistributive monetary policy. Given such an anticipatedmonetary policy, it pays banks to be conservative and the competition among the banksmight induce a race to the top in prudence. In this case, monetary policy mitigatesrisk taking. In contrast, if it is known that the central bank will increase the price ofmortgage-backed securities in case of a downturn, banks will lend more aggressivelyin the run-up and the moral-hazard problems are aggravated. While the purchase ofmortgage backed securities is more targeted and hence more ex-post efficient, it createslarger ex-ante moral-hazard problems.This way of thinking about monetary economics has also important ex-ante implications.Central banks should be concerned that they may be pushed into a corner, in whichtheir actions are dictated by financial-stability considerations. To avoid a ‘financial99
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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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Page 66 and 67: The evolution of modern centralbank
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Page 90 and 91: Nominal-GDP targets, without losing
Page 104 and 105: A broader mandate: Why inflationtar
Page 120 and 121: Will central banking change?Charles
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Is inflation targeting dead? Central Banking After the Crisis - Vox

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