Inflation targets need rethinking

WASHINGTON: Central banks need to rethink inflation targets to tackle future financial crises more effectively, IMF chief economist Olivier Blanchard suggested on Friday.

A research report by Blanchard and associates at IMF said policymakers became too complacent during the period of expansion known as “the Great Moderation” about issues such as inflation and debt. He said that while the financial sector was the source of the recent crisis, “large adverse shocks” could come from elsewhere in the future such as a pandemic or major terrorist attack.

Against this backdrop, he said aiming for a higher inflation rate could provide more room for policymakers to grapple with crises.

“Maybe policymakers should therefore aim for a higher target inflation rate in normal times, in order to increase the room for monetary policy to react to

such shocks,” Blanchard said in

a report “Rethinking Macroeconomic Policy.”

“To be concrete, are the net costs of inflation much higher

at, say, four per cent than at

two per cent, the current target range? Is it more difficult to anchor expectations at four per cent than at two per cent?” asked Blanchard, an economist on leave from the Massachusetts Institute of Technology.

At the same time, he said, it was clear that achieving credible low inflation through central bank independence had been a historic accomplishment, especially in several emerging markets.

“Thus, answering these questions implies carefully revisiting the list of costs and possible benefits of inflation,” he said. “Nevertheless, it is worth considering whether these costs are outweighed by the improved policy maneuverability that would be available in times of crisis from having slightly higher inflation.”

He said that interest rates were a “poor tool to deal with excess leverage, excessive risk taking, or apparent deviations of asset prices from fundamentals. “We need a combination of monetary and regulatory tools.”

Blanchard pointed out that the basic elements of the pre-crisis policy consensus still held — “Keeping output close to potential and inflation low and stable should be the two targets of policy. And controlling inflation remains the primary responsibility of the central bank. But the crisis forces us to think about how these targets can be achieved.”

The recent financial crisis, which erupted after a home mortgage meltdown in the United States, plunged many economies, mostly developed ones, into the worst recession in decades.

In the United States, the Federal Reserve pumped trillions of dollars into the economy to jolt the world’s largest economy from recession.

But fears arose on how the US central bank will mop up these money as the economy recovered to avoid runaway inflation. “As the crisis slowly recedes, it’s time for a reassessment of what we know about how to conduct macroeconomic policy,” Blanchard said