Central Banks Ponder Going Beyond Inflation Mandates
Inside the world’s oldest central bank, a new debate is raging over a dilemma facing monetary authorities around the globe.
Policy makers at Sweden’s 344-year-old Riksbank and elsewhere are arguing about how far they can look beyond their price mandates and focus instead on economic growth, employment or financial stability when inflation threats are either not pressing or deemed to be passing. This marks a shift from three decades in which central bankers battled inflation, an enemy they understood so well that most made it their singular emphasis in the 1990s.
“There are lots of things central banks are worried about at the moment, and inflation is not the highest priority,” said Stephen King, chief economist at HSBC Holdings Plc in London and a former U.K. Treasury official. “As long as people believe central banks are committed over the longer term to price stability, there is leeway to play around with other objectives.”
How much they should lean toward alternate goals is contentious. At the Riksbank, Deputy Governor Lars E.O. Svensson, who once taught economics alongside Federal Reserve Chairman Ben S. Bernanke at Princeton University in New Jersey, says keeping inflation too low hurts hiring, while Governor Stefan Ingves has said he worries about a debt bubble arising from low interest rates. The Riksbank left its benchmark rate unchanged at 1.25 percent at its October meeting.
Meanwhile, the Bank of England has ignored three years of above-target inflation as it tries to tackle slow growth in an economy just emerging from a recession. The European Central Bank faces internal criticism for proposing to buy bonds of cash-strapped nations. The Bank of Japan (8301)’s rejection of more- radical policy options in a period of moderate deflation has become a key political debate ahead of Dec. 16 elections.
Bernanke’s Fed is leading the way toward a broader mission, thanks to its dual mandate of achieving stable prices and maximum employment. After decades of emphasizing low inflation, it now aims policy at reducing the jobless rate.
The Federal Open Market Committee meets this week after Bernanke announced an open-ended program in September to purchase $40 billion in mortgage-backed securities a month. The buying -- which probably will push the Fed’s balance sheet beyond $3 trillion -- will stop only when the labor market improves “substantially,” the Fed said.
Unemployment was 7.7 percent in November compared with 4.7 percent before the 18-month recession began in December 2007.
The Fed may boost its holdings further by adding outright purchases of Treasuries, according to investors and analysts such as Stephen Oliner, a resident scholar at the American Enterprise Institute in Washington, a research group that promotes free markets.
Such policies would be unthinkable if inflation wasn’t dormant or forecast to be. The Fed’s preferred price benchmark rose 1.7 percent in October from a year earlier, near the 2 percent goal.
“They are now poised to really blow up the balance sheet over the next year or more as their prime tool to make sure they can do something about the high level of unemployment,” Oliner said.
Other central banks probably will follow the Fed’s embrace of more stimulus in 2013, according to Nathan Sheets, New York- based global head of international economics at Citigroup Inc. Citigroup predicts that inflation in developed countries will slow to 1.7 percent next year from 1.9 percent this year.
“The ongoing challenges facing the major economies, coupled with our subdued projections for inflation, suggest that central banks will remain broadly expansionary through 2013 and probably well beyond,” said Sheets, Bernanke’s top adviser on international economies from 2007 to 2011, in a Nov. 26 report.
With interest rates in major economies near zero and quantitative easing facing diminishing returns, policy makers may consider fresh unorthodox tools, according to economists at Societe Generale SA. The Bank of England already is trying to boost credit, the Bank of Japan has purchased assets beyond bonds and the Swiss National Bank has capped its franc against the euro.
The impact on stocks from central banks’ concern for economic growth and employment is “unambiguously positive,” said Allen Sinai, chief global economist at Decision Economics Inc. in New York.
King’s colleagues at HSBC cite aggressive stimulus as the main reason for anticipating a return of about 9 percent next year in the MSCI All Country World Index, which tracks 2,443 stocks worldwide. The index has risen about 12 percent this year, compared with a 9 percent decline in 2011.
“Explicitly in the U.S., or de facto in other countries, central banks are much more focused on the growth side” of their mandates, Sinai said. “They have no choice but to maintain easy policies because the policy problem is too little growth, too high unemployment and too much debt.”
Inflation is low or appears well anchored elsewhere. In Sweden, consumer prices rose just 0.4 percent for the year ending October and have been increasing less than 1 percent since July, about half the Riksbank’s 2 percent target. Two-year break-even rates, a measure of inflation expectations, are less than 0.5 percent. A similar indicator in Germany was about minus 1.8 percent last week.
There are several reasons why central bankers are taking on, or at least talking about, broader objectives. They are more confident in their understanding of how inflation works after years of trying to control it and now have a track record of capping expectations, which has “bought them room to be aggressive in other ways,” said Mark Zandi, chief economist at Moody’s Analytics Inc. in West Chester, Pennsylvania.
“They worked for a quarter century to gain credibility, and they should use it,” he said.
Since central banks exist because their legislatures want them to be partners in economic prosperity, they can’t maintain political credibility by focusing only on low inflation amid high unemployment and weak growth, Sheets said.
In Japan, Shinzo Abe, head of the opposition Liberal Democratic Party who is leading in polls to be the next prime minister, has criticized the central bank for failing to escape deflation and said he wants “unlimited easing” until it achieves 2 percent inflation.
Japanese consumer prices excluding fresh food fell in five of the six months through October, and the LDP’s manifesto says it may legislate to increase cooperation between the government and BOJ.
“We want to push ahead with anti-deflationary policies on a new level,” Abe said in a Nov. 29 debate. His call for “bold monetary easing” helped push the yen to a seven-month low against the dollar in November.
Even in countries where inflation is above target, central bankers seem more concerned with escaping a cycle of joblessness and economic malaise.
The Bank of England’s 2 percent inflation goal has been breached every month since December 2009. Inflation was 2.7 percent in October, even though the economy this year fell into its first double-dip recession since the 1970s and unemployment has stalled above 7.5 percent since May 2009.
The U.K. central bank has held its benchmark rate at a record-low 0.5 percent since March 2009 and bought 375 billion pounds ($601 billion) of assets. It has argued that trying to bring inflation back to the target too quickly could lead to economic pain.
In an interview with yesterday’s Observer newspaper, U.K. Business Secretary Vince Cable said he would like the Bank of England to have a more explicit target to bolster expansion.
While Governor Mervyn King said in an Oct. 9 speech it’s “too soon to bury” the concept of inflation targeting, he added it is sometimes “justified to aim off” the goal to moderate the risk of financial crises. Bank of Canada Governor Mark Carney, who will succeed King in July, says he doesn’t take a dogmatic approach and has advocated flexibility.
Central bankers do have constraints. Some Fed officials have said their soaring balance sheet means selling the assets will be difficult when the time comes to exit. Norway’s central bank Governor Oeystein Olsen signaled in September that policy makers are struggling to reconcile a potential housing bubble with low inflation and exporter demands for rate cuts to cool krone gains.
The ECB, traditionally perceived by economists as the most loyal to its inflation target, also faces accusations from within its Governing Council that it is stretching its focus beyond price stability with a proposal to buy bonds of countries that first agree to fiscal goals. Spain is considering whether to sign up.
Such conditionality is “unprecedented,” said Larry Hatheway, the chief economist at UBS AG in London. “It does seem to move beyond what we’ve envisaged central banks are mandated to do.”
President Mario Draghi says the purchases will help unblock the so-called monetary transmission mechanism by encouraging cash-strapped banks to pass on the ECB’s record-low 0.75 percent interest rate. He said that meshes with the goal of ensuring price stability.
With its economy in recession and unemployment at a record 11.7 percent, the ECB forecast last week that inflation will average about 1.6 percent next year and about 1.4 percent in 2014, compared with 2.5 percent this year.
The greater risk to price stability “is currently falling prices in some euro-area countries,” Draghi said Oct. 24 in Berlin. So bond purchases under the ECB’s Outright Monetary Transactions program “are not in contradiction to our mandate; in fact, they are essential for ensuring we can continue to achieve it.”
In a sign the door is open for easing monetary policy further, Draghi said Dec. 6 there was a “wide discussion” on interest rates at that day’s meeting of his 23-member Governing Council before it left policy unchanged. A majority of participants were open to cutting the rate, and there is a possibility of a reduction early next year if the economy doesn’t pick up, three officials with knowledge of the council’s deliberations said.
Bundesbank President Jens Weidmann has been alone on the council in voting against the bond-buying strategy, on the grounds it’s tantamount to printing money to finance governments, which the ECB’s founding treaty prohibits.
“The intervention purchases must not be permitted to jeopardize the capability of monetary policy to safeguard price stability,” Weidmann said Sept. 6.
Inflation expectations, as measured by the ECB’s latest survey of professional forecasters, are consistent on average with the central bank’s goal. Even so, the economists gave an 8.8 percent probability of inflation being over 3 percent in the medium term, up from 3.4 percent five years ago.
Traditional inflation-targeting regimes may be outdated, given the need of consumers, companies and governments to reduce debt, said Manoj Pradhan, a global economist at Morgan Stanley in London. Concentrating on prices could make that process costlier and generate even weaker growth and perhaps deflation, he said, suggesting instead a conditional goal that allows higher prices until debts and growth are sustainable.
“By forcing central banks to focus on inflation, and indeed on restricting inflation to its low pre-crisis level, these mandates could possibly erode the very credibility that central banks are keen to protect,” Pradhan said.
While officials shouldn’t be negligent about price pressures, former Bank of Mexico Governor Guillermo Ortiz’s experience suggests there is room to maneuver.
“The efforts that have been made to control and bring down inflation are precious commodities,” Ortiz, now chairman of Mexican banking group Grupo Financiero Banorte in Mexico City, said in an interview. Policy makers “would certainly be wise not to lose that.”
When he became head of the central bank in 1998, he was battling inflation in excess of 10 percent. As it fell into the single digits, the central bank was able to broaden its scope. Now, with inflation low, monetary authorities are right to concentrate on stabilizing their economies and financial markets, he said.
“As we were feeling more comfortable with inflation, we were able, as a central bank, to focus -- although it was not in our direct competence -- on potential growth in Mexico and structural reforms and fiscal policy,” he said. “We could have hardly done” that without low inflation.