How much agony do we have to endure first?
To wean central banks from inflation targeting you’ll have to snatch it from them by force; they are clutching it ever more tightly to their breasts. But they must bid it a tearful goodbye.
The big question is what will replace it.
Mark Carney has said that: “Flexible inflation targeting is the most successful monetary framework that has been in existence.”
Welcome to the Orwellan world of central bank Newspeak. Inflation has remained above target since 2009 in the UK and will stay above target for the foreseeable future. And that’s official. Unless of course the target is raised…or Carney gets that extra flexibility (ha,ha) that he says he needs.
They have drummed into us that “flexible” (ha,ha) inflation targeting means maintaining the anchor to prices in the longer term, but when the long term is an ever-receding point the entire exercise loses meaning and credibility. That point was to my mind reached more than a year ago, but other commentators are only now coming round to that view.
Hence Carney’s call for “ a great debate” on inflation targeting.
Martin Wolf points out that proponents of the current IT regime (of which he was one) justified it not only on the proposition that it would stabilise inflation, but that it would help stabilise the economy: It failed to do so.
“The current regime is meant to stabilise inflation and help stabilise the economy. It has failed.”
He calls for an official inquiry into the IT regime – another way of burying it.
But Martin Wolf does that en route to endorsing an even more desperate and dangerous exercise in discretionary activism:
“Yet I agree with Lord Turner that the even more important question is how to make any policy effective. This, inevitably, raises questions about how monetary policy works in an environment of ultra-low interest rates. Lord Turner thinks the unthinkable: namely, monetary financing of the fiscal deficit. So should policy makers. They have to think afresh.”
In The Money Trap, I make three key propositions:
1. That the inflation targeting regime has failed – it will always be too closely associated with the greatest monetary and economic crisis ever and the failure to recover from it. Confidence in discretionary monetary policy has collapsed. Driving interest rates close to zero, keeping zombie companies alive, abolishing any incentive for banks to lend in the inter-bank market (traditionally a critical sourve of marginal funding) and then hoping something will turn up is not a policy to commend itself to any rational person.
2. That if countries insist in keeping flexible exchange rates, the only alternative monetary rule is a strict form of monetary base control – the only monetary aggregate under the control of the central bank – with no discretion. This is the closest you can get to the disciplne of the gold standard at a national level. But thirdly
3. There are no other viable monetary policy rules under fiat money.
Do we have to go through the exercise suggested by Messrs Turner and Wolf of proving yet again that printing enough money will produce inflation in the end? All the great economists cited by Turner knew that. But the relevant question is: what evidence if any is there that such monetary financing will lead to growth rather than inflation? As Rajan has pointed out, until the supply side of the economy adjusts – getting rid of products and services that were the product of bad investments made in the boom years pre-2007 – it does no good just to recreate demand for goods that people don’t want:
“The only sustainable solution is to allow the supply side to adjust to more normal and sustainable sources of demand…. The worst thing that governments can do is to stand in the way by propping up unviable firms or by sustaining demand in unviable industries through easy credit.
For serious commentators to advocate abandoning the current monetary rule, such as it is, is a sign of desperation. Of course politicians will snatch at such ideas – they would like nothing better than intellectual cover for currency manipulation. The resulting inflation tax will enable them to offer more goodies to the public and their friends.
We face a choice between resorting to increasing despeerate measures, including protectionism, and to re-establishing strict monetary control – as advocated for example by Brendan Brown in his new book, “The Global Curse of the Federal Reserve”, or returning to convertibility – making money redeemable at a fixed price into a real asset.
Too many economists suffer from the old delusion: that with adroit timing and brilliant footwork a new breed of infinitely wise central bankers (advised by them) can turn on the monetary spigots just for long enough to spur demand and then quickly turn them off to preempt accelerating inflation. But such arrogant assumptions no longer carry credibility.
Strict monetary control – such as that guaranteed by monetary base control or convertibility into real assets at a fixed price – are the historically tried and tested methods not only for controlling money and credit creation but also for providing a predictable monetary and macro environment for businesses and households to plan their future expenditure. This is what gave Britain 900 years of relative monetary stability. Nothing else has ever worked.