Is flexible inflation targeting still fit for the purpose it must serve?
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Is ‘flexible inflation targeting’ (FIT) ripe for a coup d’état that topples its almost three-decade grip on the ruling dispensations of central banks the world over? Pioneered by New Zealand as early as 1990, and soon emulated by Canada and the United Kingdom, FIT is now the de jure, or de facto, monetary policy of most major advanced and emerging market central banks, including the Reserve Bank of India (RBI).
Doubts about whether FIT was fit for the purpose began to grow after the global financial crisis of 2007-2009 and its aftermath. As this column has discussed several times, a monetary policy fixated solely on consumer price inflation (CPI), or some variant, failed to react to asset price bubbles that eventually burst and threatened to topple the entire global monetary and financial edifice.
The Covid-19 pandemic has caused worldwide economic devastation. In the EU and the United States, many early emergency measures sought to address the shortcomings and disorganization of health care systems. Other policy measures were textbook demand-management and liquidity-provision programs, not unlike those adopted during the 2008-2009 global financial crisis.
While many economists called attention on the supply-side impact of a pandemic-driven economic crisis, policy measures implemented in 2020 mostly discarded this caveat. Assuming that the demand shock is much stronger than the supply shock, the fall in output could only be accompanied by stable or falling prices. This dominant mindset is summarized by economist Joseph Stiglitz, who in February 2021 referred to inflation as a “bogeyman that is more fantasy than real threat nowadays”.
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(Reuters) - U.S. central bankers on Friday signaled they do not plan to touch the dial on their super-easy policy for some time, expressing little concern over the rapid rise in U.S. Treasury yields in recent weeks, and hope for a robust recovery.
FILE PHOTO: The Federal Reserve building is pictured in Washington, DC, U.S., August 22, 2018. REUTERS/Chris Wattie
A drop in infections, accelerating vaccinations and likely passage of a $1.9 trillion pandemic relief package have driven a surge in bond yields. Some who worry about inflation have speculated the Fed would act to bolster its current bond-buying program to push down long-term borrowing costs.