Time for an opportunistic inflation

The title of this post is a play on a paper by Orhapnides [ex Governor of the central bank of Cyprus] and Wilcox, the Opportunistic Approach to Disinflation.  That paper described a policymaker that would not seek to engineer low inflation through deliberate monetary policy, but would wait for the good fortune of disinflationary shocks to do it for them, locking in low inflation later.

What is the relevance of this now?

Post the Great Financial Crisis, the UK and other economies are stuck with very low real rates for the foreseeable future.  Other things equal, this means lower central bank rates.  The resting point for rates is perhaps as low as 2-3%.  This means that there is little room to respond to the next crisis.  Recall that interest rates started out at 5.5% in the Summer of 2008.  A way round this is to raise the inflation target.  This would, once met, tend to raise the resting point for central bank rates.  There are arguments against.  Getting a reputation for moving the monetary goalposts.  The traditional case for the costs of inflation which underpin the inflation target in the first place.

Another – and a clincher for me at the time – was the fact that central banks were having a lot of trouble hitting the old target of 2%.  Raising the target was just setting up the central bank for failure.

But here comes the relevance of the opportunistic approach.  In the UK, the unfortunate decision by UK voting turkeys to vote for their economic Christmas caused Sterling to fall, and has led to a protracted period of inflation greater than 3%.  In some ways this is the perfect time to raise the target.  There is a good chance of achieving it, with the right mix of monetary and fiscal policy, and a good chance of a promise to hit a higher target being believed, with inflation itself already high.

Some would cry foul, and assume that the authorities were never serious about the target, and complain that the higher target would be a step along a slippery slope.  But despite those risks it would be worth it to regain monetary potency in time for the next recession.

If you think QE is a perfect substitute for conventional monetary policy, or you are happy with the de facto return of managing the inflation target back to the Treasury, who wield the other remaining fiscal instruments, or you are ok with reforming monetary institutions to allow for very negative interest rates, then you won’t see raising the target as necessary or desirable.  But if you are not wholly in any of those camps, you should.

The implied position of the Government and in particular Mr Hammond, given the recent renewal of the inflation target remit, is that everything is fine as it is.  With inflation now fortuitously high, time to look at this again.

The Labour Party seem to have been doing some thinking about shaking up the Bank of England.  But it is distressing that with important matters of policy substance that could be addressed, like the level of the target, they chose to focus instead on the case for moving it to Birmingham.

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