A subtle shift in monetary policymaking is afoot with a new generation of central bankers, striving to secure global economic recovery, prepared to challenge the old doctrine of inflation-fighting at all costs.
Mark Carney, the governor of the Bank of Canada (BOC) and soon-to-be head of the Bank of England (BOE), might or might not have intended to spark a high-level debate last week over how diligently central banks should fend off inflation.
However, he did just that with his speech in Toronto on the BOC’s flexible approach to prices, and his musings on alternative approaches to policy that the Canadian central bank had considered but dismissed.
Within two days, Britain’s chancellor of the exchequer, two BOE policymakers and numerous economists had weighed in on what Carney’s comments meant for the country and for the future of central banking.
The sharp reaction reflects unease with a change in the way the world’s major central banks approach policy in an era of slow recovery from world economic crisis.
Policymakers from the US Federal Reserve to the Bank of Japan (BOJ) have reconsidered or relaxed their inflation targets — long the raison d’etre of monetary policy — and have given more emphasis to economic growth, even if that is not an official mandate.
“They have reduced their slavish devotion to the sole goal of inflation targeting,” Carl Tannenbaum said, a former Federal Reserve official who is now chief economist at US asset manager Northern Trust.
No central banker is going to tolerate an inflation spike in order to boost employment or foster more growth.
Policymakers have also largely dismissed some of the more radical alternatives to achieving their goals, most notably targeting levels of nominal GDP (real GDP plus inflation).
Yet with the financial crisis having starkly exposed central banks’ failure to stave off danger and policymakers having responded by flooding world markets with trillions of dollars in cheap funding, a small run-up in inflation may no longer be the anathema it once was.
In the world’s largest economy, US Federal Reserve Chairman Ben Bernanke has unleashed some US$2.5 trillion in asset purchases in the last few years to boost hiring and economic growth, squarely focusing on the employment side of the US central bank’s dual mandate.
His approach differs to that of his veteran predecessor, Alan Greenspan. The same goes for Mario Draghi, who took over from Jean-Claude Trichet as president of the European Central Bank (ECB) and it looks like Carney, replacing Britain’s Mervyn King, fits the same pattern.
The US Federal Reserve last week tied low interest rates to a drop in the jobless rate to 6.5 percent — it stood at 7.7 percent last month — as long as inflation did not threaten to top 2.5 percent.
The unprecedented move could represent the culmination of its departure from the inflation-centric model pursued by former US Federal Reserve chairmen Greenspan and Paul Volcker, giving a clear signal that it would tolerate inflation above its 2 percent target if that was the cost of getting more people in the US back to work.
Eric Green of TD Securities, a former New York Fed economist, wrote that “Bernanke has relaxed the inflation constraint,” effectively raising the Fed’s core inflation target over time from 1.75 percent to 2.5 percent.