The Chief Economist at the IMF becomes an inflation targetting evangelist in today's FT. Normally I give an unequivocal welcome to the breath of fresh air Rogoff has brought to IMF economics, but here I can't help feeling he is way off target. He seems to miss the deflation problem entirely and treat the interaction of political and economic objectives as if this was a simple 'technical' question. As everyone knows the US treasury is hell bent on provoking inflation provoking deficits, Bernanke down at the Fed cannot really disagree. What would be 'moderate' inflation? 4%, 5%? So at least noone can complain is that the US authorities are not making their inflation targeting (useful 'double entendre' here) clear. What many less people seem to recognise is that this may be a sophistocated game of poker, where the interaction between the central banker and the politician may be central.In fact 'destructive ambiguity' may be what the game is all about. Or are we to assume that the public at large are a bunch of simpletons?
Even those of us who are not inflation-targeting fanatics are starting to wonder why the G3 central banks (Bank of Japan, the European Central Bank and yes, even the US Federal Reserve) seem so reluctant to speak more openly and concretely about their long-term inflation objectives. What harm would there be in giving broad guidelines for, say, average consumer price inflation over the next five to 10 years? One can think of some concerns but do they really outweigh the potential benefits? Yes, each of these large central banks faces special challenges, but the broad general issues are really the same.
The principal argument in favour of more transparent and specific official long-term inflation objectives is to make it easier for markets to interpret central bank policy. With long-term inflation expectations more firmly anchored, long-term interest rates might jump around a bit less, and businesses and investors might find it easier to draw up long-term contracts.
Admittedly, monetary policy in both the US and the eurozone has vastly improved over the last two decades, and long-term inflation expectations are correspondingly more stable. But could a bit more transparency hurt? Besides, there are other potential benefits to anchoring expectations. For the BoJ, the failure to communicate a clear strategy on inflation over the past five years has helped confound all efforts to escape the country's deflation sand-trap. Surely annual yields on 10-year yen bonds would not be below 1 per cent if people envisaged a clear end to the country's long bout with falling prices. True, there is relatively little danger of seeing broad-based embedded deflation take root in the US or the eurozone, but it is clearly an outside risk. If the Fed, in particular, had in place a framework for anchoring long-term inflation expectations, there might be less need to worry about having to use unorthodox anti-deflation weapons such as purchasing long-term securities.
And then there is the perennial problem of the changing of the guard. This is a much discussed concern in the US, but in some ways no less of an issue for the euro area and Japan. Would not some clarity over long-term inflation objectives help to calm markets?
There is another delicate matter: while much of the world currently enjoys an outstanding group of central bankers, what if some future appointees were less competent and perhaps less committed to controlling inflation? Wouldn't having a long-term inflation guideline help mitigate the problem, at least marginally?
The interesting question is why reject this small non-addictive dose of inflation-targeting? The most compelling argument, perhaps, is the "slippery slope" defence: if one of these central banks were to issue broad guidelines for five- to 10-year average inflation, it would only be a short hop, skip and a jump to far more narrowly construed inflation targeting, say along the lines of the Bank of England. Worse things could happen, although it is important for the largest central banks to retain considerable flexibility and discretion. In today's complex global environment, difficult-to-imagine uncertainties form the exception that proves the rule.
Another concern is the inflation guideline itself. What if a central bank chooses the wrong one? This counter-argument seems pretty feeble. Central banks have implicit guidelines anyway, and if they do seem misguided, then all the more reason to hear the central banks' thinking. What kind of targets make sense: 2, 3, zero per cent? These are technical questions, but suffice it to say that in currency unions that are less well integrated, both in terms of fiscal policy and labour mobility, a higher inflation objective is needed to reduce the odds of localised deflation. And positive and negative deviations from the guidelines ought to be treated symmetrically.
What about the fact that there is a variety of indices of inflation, and none is quite right for everything? True, but as long as the central bank is clear on its aims, markets ought be able to adjust accordingly. In any event, in the universe of macroeconomic concepts, inflation is something we measure relatively precisely, compared, say, to output or unemployment.
What I propose is a small step. I do not regard transparency of long-term inflation objectives as being more important than maintaining central bank independence, or than having conservative central bankers with strong anti-inflation credibility. Indeed, looking over the next 40 years, one has to be concerned about burgeoning fiscal deficits and ballooning old-age transfers in the biggest economies. Monetary institutions must remain strong or the irresistible force of fiscal profligacy will once again overwhelm all inflation resistance. A greater measure of inflation transparency can only help. It is time to end policies of destructive ambiguity.
Source: Financial Times
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