Those Inflation Targets Keep Getting Harder to Hit

Central banks have promised higher inflation is on its way. They’ve promised that before
Illustration: Braulio Amado

Central bankers are failing to meet their own standards for inflation. With growth and trade down in much of the world, inflation is lower than they want it to be across the biggest economies: the U.S., Europe, Japan, and China.

Yet when central bankers met for the Jackson Hole Economic Policy Symposium in Wyoming in late August, the talk was about how inflation was really, truly, finally about to rise—in spite of the economic and market turmoil that was going on at lesser altitudes. “There is good reason to believe that inflation will move higher as the forces holding down inflation dissipate further,” Fed Vice Chairman Stanley Fischer said in his prepared remarks. Bank of England Governor Mark Carney’s prepared remarks cited “the prospect of sustained momentum” in the economy and a gradual pickup in inflationary pressures. And European Central Bank Vice President Vítor Constâncio said that as long as Europe can succeed in gunning growth, “we can rely on a material effect to help bring the inflation rate closer to target.” Speaking in New York City on Aug. 28, Bank of Japan Governor Haruhiko Kuroda insisted that Japan could hit its 2 percent inflation target next year, even though the latest reading for its preferred measure of inflation was precisely zero.

In the U.S., the Federal Open Market Committee is leaving open the possibility of raising the federal funds rate at its next meeting on Sept. 16-17, despite inflation that’s been running below the Fed’s target since April 2012. As reflected in futures contract pricing, the probability of a September increase in the funds rate dipped as low as 24 percent on Aug. 26 after global market gyrations. As of Sept. 2, the futures market was putting a 30 percent probability on a September rate increase.

Central bankers generally want a little inflation—2 percent is a typical goal—because it greases the gears of commerce. It’s a sign that demand is strong enough to put upward pressure on prices. When prices are rising, it’s possible to set interest rates below the inflation rate, stimulating borrowing. And troubled businesses can save money while avoiding layoffs by giving workers wage hikes below the inflation rate. Neither tactic is possible in a zero-inflation world.

Chart: missing the mark

Slumping growth, however, reduces the likelihood that central bankers will get what they seek. China’s official factory gauge fell in August to its lowest in three years. Japan’s industrial production slumped in July, the government announced. In the U.S., which has powered ahead better than most, manufacturing in August expanded at its slowest pace since May 2013.

At Jackson Hole, academics delivered a beating to central banks’ confidence in their ability to predict and manage inflation by pointing out wide gaps in knowledge about how inflation works. Boston University’s Simon Gilchrist said strict inflation targeting doesn’t pay enough attention to financial shocks, which can disrupt economic output. Trying to influence inflation while not understanding it is a “recipe for disaster,” MIT Sloan School of Management professor Athanasios Orphanides, a former ECB Governing Council member, said as a panelist.

ECB President Mario Draghi skipped Jackson Hole, but he can’t dodge this: Less than six months into a stimulus program that he promised would revive inflation, the euro area faces renewed disinflationary pressure. The ECB forecast in June that price gains would average 1.5 percent next year and 1.8 percent in 2017, provided its stimulus is fully implemented. The ECB’s goal is inflation less than but close to 2 percent. That could be harder to achieve, given slower global growth. Philippe Gudin, chief European economist at Barclays in Paris, wrote in an Aug. 28 note to clients that the bank expects the ECB to do more bond-buying before yearend on top of its current €1.1 trillion ($1.2 trillion) program.

Japan’s Kuroda is also under pressure to do more, regardless of his reassurance that monetary policy is on track. Only one economist in a recent survey by Bloomberg said inflation would reach the Bank of Japan’s goal on schedule. And that survey was done before China’s stock market worsened and the yen rose. “Deflation is the big problem for Japan,” says Junko Nishioka, the chief economist at Sumitomo Mitsui Banking.

Narayana Kocherlakota, president of the Federal Reserve Bank of Minneapolis, worries that central bankers can’t lower rates much more in case of further disinflation or outright deflation. Benchmark interest rates at all the world’s major central banks are close to or even below zero, and together they’ve pumped trillions into their financial systems since the onset of the financial crisis. “I look at Japan, Europe, U.K., the Canadians—you just see that more and more countries are getting close to their effective lower bounds,” that is, the lowest rates can possibly go, Kocherlakota said in an interview in Jackson. “This is the challenge facing central banks.”

The bottom line: Central bankers say they can raise inflation to reach their targets, but interest rates at about zero won’t be any help.

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