A feature of the credit crunch era is the repetition of various suggestions from governments and central banks. One example of this has been the issue of Eurobonds which invariably has a lifespan until the nearest German official spots it. Another has been the concept of central banks overshooting their inflation target for a while. It is something that is usually supported by those especially keen on ( even more) interest-rate cuts and monetary easing so let us take a look.
Last Wednesday European Central Bank President Mario Draghi appeared to join the fray and the emphasis is mine.
Well, on your second question I will answer saying exactly the same thing. We don’t tolerate too low inflation; we remain fully committed to using all necessary instruments to return inflation to 2% without undue delay. Likewise, our inflation aim doesn’t imply a ceiling of 2%.Inflation can deviate from our objective in both directions, so long as the path of inflation converges towards our medium-term objective. I believe I must have said something close to this, or something to this extent a few other times in the past few years.
Nice try Mario but not all pf us had our senses completely dulled by what was otherwise a going through the motions press conference. As what he said at the press conference last September was really rather different.
In relation to that: shouldn’t the ECB be aiming for an overshoot on inflation rather than an undershoot given that it’s been below target for so long?
Second point: our objective is an inflation rate which is below, but close to 2% over the medium term; we stay with that, that’s our objective.
As you can see back then he was clearly sign posting an inflation targeting system aiming for inflation below 2%. That was in line with the valedictory speech given by his predecessor Jean-Claude Trichet which gave us a pretty exact definition by the way he was so pleased with it averaging 1.97% per annum in his term. So we have seen a shift which leads to the question, why?
The actual situation
What makes the switch look rather odd is the actual inflation situation in the Euro area. Back to Mario at the ECB press conference on Wednesday.
According to Eurostat’s flash estimate, euro area annual HICP inflation was 1.4% in March 2019, after 1.5% in February, reflecting mainly a decline in food, services and non-energy industrial goods price inflation. On the basis of current futures prices for oil, headline inflation is likely to decline over the coming months.
So we find that inflation is below target and expected to fall further in 2019. This was a subject which was probed by one of the questions.
It’s quite clear that the sliding of the five-year-to-five-year inflation expectations corresponds to a deterioration of the economic outlook. It’s also quite clear that as the economic outlook, especially the economic activity slows down, also markets expect less pressure in the labour market, but we haven’t seen that yet.
The issue of markets for inflation expectations is often misunderstood as the truth is we know so little about what inflation will be then. But such as it is again the trend may well be lower so why have we been guided towards higher inflation being permitted.
It might have been a slip of the tongue but Mario Draghi is usually quite careful with his language. This leaves us with another thought, which is that if he is warming us up for an attitude change he is doing soon behalf of his successor as he departs to his retirement villa at the end of October.
Minneapolis Fed President Neel Kashkari suggested this in his #AskNeel exercise on Twitter.
Well we officially have a symmetric target and actual inflation has averaged around 1.7%, below our 2% target, for the past several years. So if we were at 2.3% for several years that shouldn’t be concerning.
Also he reminded those observing the debate on Twitter that the US inflation target is symmetric and thus unlike the ECB.
Yes, i think we should really live the symmetric target and not tap the brakes prematurely. This is why I’ve been arguing for more accommodative monetary policy. But we are undertaking a year long review of various approaches so I am keeping an open mind.
As you can see with views like that the Donald is likely to be describing Neel Kashkari as “one of the best people”. If we move to the detail there are various issues and my initial one is that inflation tends to feed on itself and be self-fulfilling so the idea that we can be just over the target at say 2.3% is far from telling the full picture. Usually iy would then go higher. Also if your wages were not growing or only growing at 1% you would be concerned about even that seemingly low-level of inflation.
If we consider the review the US Fed is undertaken we see from last week’s speech by Vice Chair Clarida a denial that it has any plans to change its 2% per annum target and we know what to do with those! Especially as he later points out this.
In part because of that concern, some economists have advocated “makeup” strategies under which policymakers seek to undo, in part or in whole, past inflation deviations from target. Such strategies include targeting average inflation over a multiyear period and price-level targeting, in which policymakers seek to stabilize the price level around a constant growth path.
As the credit crunch era has seen inflation generally be below target this would be quite a shift as it would allow for quite a catch-up. Which of course is exactly the point!
Central bankers fear that they are approaching something of a nexus point. They have deployed monetary policy on a scale that would not have been believed before the credit crunch hit us. Yet in spite of the negative interest-rates, QE style bond purchases and in some cases equity and property buys we see that there has been an economic slow down and inflation is generally below target. Also the country that has deployed monetary policy the most in terms of scale Japan has virtually no inflation at all ( 0.2% in February).
At each point in the crisis where central bankers face such issues they have found a way to ease policy again. We have seen various attempts at this and below is an example from Charles Evans the President of the Chicago Fed from back in March 2012.
My preferred inflation threshold is a forecast of 3 percent over the medium term.
We have seen others look for 4% per annum. What we are seeing now is another way of trying to get the same effect but this time looking backwards rather than forwards.
There are plenty of problems with this. Whilst a higher inflation target might make life easier for central bankers the ordinary worker and consumer faces what economists call “sticky” wages. Or in simple terms prices go up but wages may not and if the credit crunch is any guide will not. My country the UK suffered from that in 2010/11 when the Bank of England “looked through” consumer inflation which went above 5% with the consequence of real wages taking a sharp hit from which they have still to recover.
Next comes the issue that in the modern era 2% per annum may be too high as a target anyway. In spite of all the effort it has been mostly undershot and as 2% in itself has no reason for existence why not cut it? Then we might make progress in real wage terms or more realistically reduce the falls. That is before we get to the issue of inflation measures lacking credibility in the real world as things get more expensive but inflation is officially recorded as low.
Meanwhile central bankers sing along to Marvin Gaye.
‘Cause baby there ain’t no mountain high enough
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