Macro View
Group Economics Macro & Financial Markets Research
27 October 2015
Time for a globally co-ordinated increase in inflation targets Nick Kounis
Central banking is in crisis, with inflation goals persistently missed,
Head Macro & Financial Markets Research
uncovential policies becoming the convention and ‘beggar-thy-
Tel: +31 20 343 5616
neighbour’ currency depreciation common place
nick.kounis@nl.abnamro.com
This article argues that it is time for a radical re-think: a globally coordinated increase in inflation targets can free monetary policy from the problems of the zero bound and reduce the risk of deflation
Monetary policy is in crisis The major central banks are failing to meet their goals. Policymakers the world over have had to resort to unconventional policies. Trillions of dollars of assets, mainly government bonds, have been purchased. ‘Beggar-thy-neighbour’ currency depreciation has become common place. Forward guidance has become increasingly desperate. Yet inflation has been persistently below target over the last few years across the advanced economies. The ECB and BoJ are gearing up to step up QE, while the Fed and BoE are struggling to raise interest rates even a little above zero. How will central banks break out of the rut? Some have suggested that it is time to give up. A two per cent inflation target is no longer achievable they argue, so why pretend. Lower inflation targets and stop QE. Simple. This would be exactly the wrong thing to do. Lowering inflation targets would push up real interest rates further, slow growth and further lower the future trajectory of inflation. The risk of deflation in case of a new demand shock would significantly increase. Throwing in the towel could have grave consequences. Time for a radical re-think: from 2% to 4% It is time for central banks to take determined action to bring back inflation and free monetary policy from the problems of the zero bound for nominal interest rates. Heavyweight economists - such as Larry Summers, Olivier Blanchard and Paul Krugman - have made a convincing case for higher inflation targets over the long term. For instance, a 4% inflation target would allow real interest rates to decline much further. Significant policy easing could be achieved without turning to QE. Central banks would have a bigger buffer to avoid deflation. The costs of 4% inflation compared to 2% inflation are negligible.
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Macro View w - Time forr a globally co-ordinated c d increase in inflation targets - 27 O October 201 15
The Fe ed, ECB, BoJ and BoE and others should d issue a jointt statement So what are central b banks waiting for? f One conce ern is how to tra ransition to high her inflation. ally, the announ ncement needs s to be credible e. Here is a sugggestion. The Fed, F the Crucia ECB, the t BoJ, the Bo oE and others issue a joint statement that thhey are each ra aising their medium term inflation n target from 2% 2 to 4% with immediate effeect. To this aim they would onetary policy accommodatio on, which wouldd continue untiil the new commit to forceful mo goal was w in sight. ally, the more ccredible the ann nouncement is, the less furtheer easing central banks Ironica would need to do. If iinflation expectations were to o rise from say 1.5% now, to 4%, 4 real interes st rates would e effectively drop p by 250 basis points. The EC CB and BoJ wo ould then be able to o end QE earlie er than otherwise. If successfful, nominal rate tes across adva anced economies would alsso eventually climb faster and d peak at higheer levels. The ro oom for conven ntional policy e easing in the fu uture would be far greater. QE E would likely be b consig gned to history rather than becoming an incrreasingly regulaar policy tool with w diminis shing returns. ntages of glob bal co-ordinatiion Advan There are three main n advantages to o global co-ord dination. The firrst is shock and awe. The strength of the signa l would make it more credible e. Second, the credibility would also increas se because the e big central ba anks can together raise globaal price pressures, reenforcing the individu ual domestic trend. Third, adv vanced econom my currencies would w be more stable s than if an ny one central bank were to move m alone. This is s not the 70s A conc cern from the o other side of the e spectrum is that t this policy shift would be too 'successful'. The worrld may judge that t central ban nks that move tthe goal posts once, would easily do it again. Infflation expectattions may surge. We would bbe back to the 1970s 1 before we kne ew it with actua al inflation getting out of contrrol. These objections see em overdone. The T risk of run--away inflation expectations can c be mitigatted by strong ccommunication. Governments s could, for insttance, put the new target into law w, to make futu ure changes to o the target more difficult. Time to t break out o of the rut In any case, the risk seems smallerr than the poss sible future connsequences of continuing on the path we are n ow on. Moneta ary policy will never be the soource of long-te erm prospe erity, but it can smooth econo omic fluctuation ns. So it is cruccial that moneta ary policy is not hobbled by a dessire to fight the long irrelevantt battles of the past. It is time for central banks to join forces tto break out of the rut.
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Macro View w - Time forr a globally co-ordinated c d increase in inflation targets - 27 O October 201 15
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