RPT-COLUMN-Shifting central bank goal posts :Mike Dolan

November 30, 2022 10:00 PM AEDT | By Reuters
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(Repeats story published earlier. No change to text.)

By Mike Dolan

LONDON, Nov 30 (Reuters) - Making goals easier to score certainly raises excitement levels - but there's no consensus on whether it improves the game.

A debate on lifting central banks' inflation targets re-surfaced this week - feeding speculation about just how much economic pain monetary policymakers are willing to inflict to drag decades-high inflation back to largely arbitrary 2% goals.

Former International Monetary Fund chief economist and long-term advocate of higher inflation targets Olivier Blanchard thinks 3% could and probably should be the new 2%. Ex New York Federal Reserve chief Bill Dudley thinks the Fed should resist the temptation at all costs.

With inflation still in double digits in Europe, just shy of 8% in the United States and borrowing costs still rising to contain it, it's easy to see why it's an appealing notion.

But the idea is far from new and its implications not always intuitive. Amorphous definitions of 'price stability' circulated for decades before 2% targets emerged as a standard in 1990s - mostly just because zero was considered an overly dangerous dalliance with deflation and anything much higher than 2% might be self-feeding.

But love of 2% soured after the financial crash of 2008.

Rapid unwinding of global debts combined with other mega disinflationary forces meant inflation struggled to stay positive, let alone 2%, and brought the 'zero bound' for interest rates up close and personal for over a decade. That prodded central banks into extraordinary asset purchases, negative interest rates or both just to try and get inflation back up to 2%.

And for some critics, excessive use of these extraordinary policy tools around the pandemic, coupled with once-in-a-generation supply shocks, ended up fuelling the inflation resurgence everyone's now trying to put back in the bottle at great cost.

Blanchard, now at Peterson Institute for International Economics in Washington, first proposed raising the 2% target to 4% to help solve the zero bound problems over a decade ago - although he has slightly tempered his advice to nudge the target up to 3%, citing research on the point at which people start changing their decision making based on rising prices.

Evidence showed the economic cost of such a move would be negligible and desirable relative wage adjustments would be easier, he argued again in an op-ed in Tuesday's Financial Times. And below 3-4% inflation, people mostly don't change behaviour but central banks have greater policy wiggle room.

And counter-intuitively for some he emphasised that higher inflation would not imply looser policy.

As the critical real, or inflation-adjusted, interest rate appropriate for the economy wouldn't change, meeting higher inflation targets would simply mean higher nominal interest rates by implication - affording greater flexibility to central banks and avoiding the need for distortive extraordinary tools.

And while the idea was rejected in 2010 due to institutional fears of a loss in credibility in raising a target you couldn't manage to get up to in the first place, it may be different approaching these inflation targets from above - as now.

"I suspect that when, in 2023 or 2024, inflation is back down to 3 per cent, there will be an intense debate about whether it is worth getting it down to 2 per cent if it comes at the cost of a further substantial slowdown in activity," Blanchard wrote, adding it may happen in practice if not officially.

So good and bad news - a potentially more balanced economy, with better wage distribution but higher nominal interest rates that may spook financial markets trying to parse the trajectory for Fed or European Central Bank interest rates years hence.


But one former central banker at least was still not enamoured.

In his own op-ed for Bloomberg and published in Tuesday's Washington Post, Dudley emphatically rejected the suggestion.

"For the sake of the economy and its own credibility, I hope the Fed doesn’t listen," the former NY Fed chief and Goldman Sachs economist wrote, adding the 'zero bound' problem was no longer the issue with rates heading to 5% and that that period may prove to be an outlier historically given developing mega trends on supply chains and climate investment.

The credibility hit from moving the target when resolve was required might also be seen as a cop out.

"Moving the goal posts would be interpreted as a failure, making it more difficult to anchor expectations around the new objective," said Dudley. "After all, if the Fed is willing to change the target once, why believe it won’t change it again?"

But one main thrust of his counter-argument was closer to Blanchard's conclusion than he may have intended.

Dudley said the Fed's strategic review in 2020 already subtly raised the inflation target by averaging the 2% over time - meaning it could now overshoot for a period to offset the decade or so it missed on the downside.

But he said there was a clear bias in this as there was unlikely to be any mention of undershooting 2% for a period to compensate for this current period of sky high prices rises.

"This asymmetry will naturally lead to average inflation of more than 2% over time, something I suspect the Fed will someday codify as official policy."

And on that point, the two economists may secretly agree.

The opinions expressed here are those of the author, a columnist for Reuters.

(by Mike Dolan, Twitter: @reutersMikeD Editing by Mark Potter)


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