In a recent post,”There’s nothing left-wing about a higher inflation target”, Tony Yates called for an increase in the Bank of England’s inflation target from 2% to 4%. Raising the inflation target for some reason would allow for higher interest rates that would provide the necessary leeway to combat economic downturns without being hemmed in by the zero lower bound.
While I do not necessarily agree with the statement I do agree with the dynamics that quite possibly underlie it. Yes, if the inflation target had been higher central banks may not have been as aggressive keeping inflation under control and possibly inflation may not have fallen to current levels. Interest rates may therefore not have trended down from the early 1990s to their pre crisis levels.
If interest rates had not moved downwards over this period then it is likely that we would have seen much less asset focussed debt creation and the foundations of the crisis that led to a precipitous immediate drop in growth and weaker growth post crisis would likely have been somewhat curtailed. The fact interest rates are hemmed in at the lower bound though has more to do with the dynamics of high levels of debt and their relationship with high asset values amidst the constraints of low economic/income growth. In other words it is the past that has the greater weight, not the future. So yes, clearly, without the debt accumulation and with higher interest rates we would possibly not be at this particular chokehold.
But, interest rates did not fall solely because inflation fell, they fell because growth rates were also falling and because of a number of financial shocks to growth starting in the late 1990s. In a sense interest rates fell to stimulate growth and anything that stimulates growth also risks stimulating inflation. That it did not is a very moot point.
In reality, all other things being equal, where inflation is caused by imbalances between supply and demand, the higher the inflation target you have the lower the interest rate target, and since I believe that lower interest rates have helped foster successive financial bubbles I am concerned over the integrity of higher inflation targets per se given the dynamics. I would have preferred higher interest rate targets and less monetary stimulus even if this had meant a lower growth trajectory. I can see little wrong with low inflation within a structurally stable economic framework.
But let us suppose the argument is one of expectations and by raising the Bank’s own inflation targets so will the general public. I think if this was the case the article should have clearly expressed it. I do not personally feel that today’s deflation is led by individuals delaying expenditure in the expectation of lower prices tomorrow, although this does not mean it could not start to happen. The question is, after all the best efforts of central banks the world over to stimulate growth over the last 20 years have led to the present moment in time of low interest rates and falling prices, how will putting an expectation of higher inflation into CB policy actually raise both inflation and interest rates?
Perhaps by raising inflation expectations we may cause consumers to spend more and save less. But this assumes that people are spending less than they are capable of (the wealthy “1%” perhaps, but do they need to spend more?) as well as the fact that deflation is impacting the saving/spending decisions of consumers.
Personally I would rather have seen a higher interest rate framework and reduced asset focussed money supply growth with lower potential inflation implications than the situation we are currently in. It has less to do with inflation and more to do with structural economic integrity. Trying to stimulate expenditure via every manner possible has led us into all sorts of problems.