IMF Chief Economist to Central Banks: Raise your Inflation Targets!
So I was reading through a Feb. edition of the Economist, when I stumbled on an article that I figured many of you would find (umm, appalling) interesting. While his idea could never happen from a policy standpoint anyway, I thought I'd share the main points with you with a brief synopsis:
Earlier this month, a study conducted by the IMF and led by the IMF chief economist, Olivier Blanchard, was released. One of the theses of their studies was that central banks, should raise their inflation targets an additional 2% in an effort to provide more flexibility when the next recession hits. His argument was that central banks had little wiggle room at the beginning of the credit crisis, and when central banks’ rates were at zero, other methods such as quantitative easing and government stimulus had to be used. Mr. Blanchard argued that the added flexibilty of raising inflation targets would outweight the drawbacks associated with the increased inflation. His basis behind this argument is that several studies show that raising inflation targets to 4% would do little harm to economic growth.
The Economist goes on to argue that 4% interest could very well create a damaging amount of price distortion, and that even if central banks had the additional flexibility, in the midst of a credit crisis and debt-loaded consumers, the added flexibilty associated with higher interest targets wouldn’t have helped anyway. (The Economist also claims that quantitative easing was a savvy move and that negative interest rates could also have been used.) From a policy standpoint, investors would likely crap their pants if debt loaded nations tried to say with a straight face that they were going to raise their inflation targets - but not to inflate their way out of debt. This, in turn, would likely lead to yet another crisis.
“As an intellectual exercise, Mr. Blanchard’s idea is intriguing. As a policy proposal, it is reckless.”