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.
North of the border, the Bank of Canada has long had an inflation target of 2 percent within a range of 1 to 3 percent.
However, unlike past BOC governors, Carney has emphasized the idea of “flexible targeting” in which inflation could be allowed to stray from the target for longer than would normally be tolerated in order to stabilize financial markets or the economy.
Carney said earlier this month that the BOC explored the idea of changing its inflation targeting mandate altogether, but decided it was too risky. He stressed he was not dropping hints about his plans for Britain, yet BOE policymakers were quick to push back on any notion the country should change its approach to policy.
Paul Fisher, the BOE’s executive director for markets, said Britain should be wary of changing the central bank’s 2 percent inflation target and had no need to adopt the longer-term commitments its North American counterparts have made on interest rates.
However, while BOE chief economist Spencer Dale warned “there is no free lunch” when it comes to changing the central bank’s target, British Chancellor of the Exchequer George Osborne surprised some when he welcomed Carney’s opening of the debate.
“If you want to change the regime you have to make a pretty strong case for doing so,” Osborne told members of parliament.
In July, Carney will replace King, considered among the last of the old guard of inflation-fighting central bankers — despite mixed success in that regard — which also included Bank of Japan Governor Masaaki Shirakawa and Trichet.
Draghi, who succeeded Trichet last year, has been careful to stick to the ECB’s price stability mantra, which is enshrined in the EU treaty and fiercely defended by Germans who are still haunted by the memory of hyperinflation in the 1920s.
Yet he has also flooded the financial sector with more than 1 trillion euros (US$1.31 trillion) this year and pledged to buy euro zone government bonds in whatever amounts are needed to shore up the currency bloc.
Two hardline ECB policymakers, Axel Weber and Juergen Stark, resigned last year over the bank’s previous bond-buying program. The pair said they felt it strayed into the realm of fiscal policy and could ultimately pose inflation risks.
In Japan, Shirakawa is under unusually explicit pressure from the next likely prime minister, Shinzo Abe, to boost the BOJ’s inflation target to 2 percent, from 1 percent, to help battle the deflation that has mired the country for the past 15 years.
Abe’s party was swept to power on Sunday last week in part on a pledge of “unlimited” monetary easing to achieve higher inflation.
In a private meeting on Tuesday last week, Shirakawa was said to have sat in silence as Abe reiterated his request for the BOJ to boost its inflation target. The BOJ duly delivered its third shot of monetary stimulus in four months earlier on Thursday. Masaaki Kanno, a former colleague of Shirakawa at the BOJ and now chief economist at JPMorgan Securities in Japan, says Shirakawa will be the last “normal” BOJ governor, one who worries about the risks posed by printing money.
“There are more and more people in Japan who want deflation to be eliminated and feel that the BOJ should be forced to use its ‘magic wand’ to create inflation,” Kanno said.
“The only option left for Japan might be for the BOJ to print money by buying more bonds,” he added. “If that’s what the public wants, [Shirakawa’s] successor will probably have to go down that route.”