Central banks around the world are struggling to meet inflation targets despite their aggressive monetary easing. Policymakers are blaming inflation shocks for their mistakes, but for how much longer can central bankers continue to make such claims?
Almost all of the world’s central banks, both in developed and emerging markets have been missing inflation targets, which brings into question the effectiveness of using such objectives in the first place. The falling oil price is to blame for some of the missed targets, but core inflation rates remain muted as well. In the US, core PCE inflation had rebounded somewhat earlier this year but seems a bit stuck at 1.6% for the past several months.
The fundamental question is, in today’s low-growth world where productivity it is falling, is inflation and the current inflation targets set by central banks appropriate measures of economic activity?
Should central banks give up on inflation targeting?
San Francisco Fed President Williams has argued that perhaps inflation targets are too low and central banks can speed the recovery by raising their goals and thereby boosting inflation expectations. Other economic commentators have suggested changing policy frameworks, to a price level or nominal income target, which builds the promise to overshoot for a time directly into the central banks’ objective.
On the other hand, there are those that argue deflation is the new normal. They see deflation as the new norm thanks to chronic overcapacity, aging demographics, and disruptive technologies. The implication is that central banks may never get back to their inflation targets (or any other target in some alternative framework), regardless of what level they are set at, as the central banks lack the tools to address these structural issues.
Bank of America’s analysts conclude that there is little evidence to suggest that the latter scenario is playing out, although they also caution that there’s no conclusive evidence showing that the scenario is not unfolding.
So how do central bankers combat persistently low inflation? Helicopter money is widely touted as one solution to Bank of America isn’t convinced that central banks will go down this path. For a start, directly monetizing the debt is illegal in most economies and helicopter money is fundamentally a fiscal policy, which cannot be initiated by central bank.
“Helicopter money cannot be initiated by a central bank: it fundamentally is fiscal policy. More importantly, how a big government tax cut or spending is financed does not really matter for supporting growth and boosting productivity how that stimulus is designed. All helicopter money does in the end is replace debt-financed fiscal policy with money-financed fiscal policy. The impact this choice will have on growth and inflation is likely second-order at best. Rather, as we argue elsewhere, a strong case can be made for targeted fiscal stimulus such as public infrastructure investment and tax simplification.”
It is quite possible for fiscal and monetary policy to be complementary without one completely dominating the other. Helicopter money via fiscal policy is just one of the tools policymakers have to help them in their quest to get inflation back to target.