Even in Its Birthplace Strict Inflation Target Loses LusterBy and
New Zealand led the world in 1990 when it introduced a target
Central bankers are debating whether to look beyond inflation
In the birthplace of a pillar of modern central banking, change is afoot.
Almost 30 years since New Zealand led the world in deciding policy would be set to keep inflation within a range, the South Pacific nation is set to ask its Reserve Bank to balance that goal with another aimed at jobs. That dual mandate would mark a dilution of strict price targeting and put the RBNZ instep with peers like the Federal Reserve and the Reserve Bank of Australia.
New Zealand’s move back in 1990 was followed by central banks around the world as policy makers pinned financial market and economic stability on their ability to keep a lid on prices. Coming after the great inflation of the late 1970s and another spurt in the 1980s, targeting prices and giving policy makers independence became central banking dogma.
Then came the great recession, and instead of trying to contain consumer inflation, most developed-world central banks have struggled in vain to stimulate prices. And so, alternatives have been debated, at confabs in the mountain valley of Jackson Hole, Wyoming, and at the central bankers’ bank in Basel, Switzerland. Now, in the Beehive parliament building in downtown Wellington, action will soon be taken.
New Prime Minister Jacinda Ardern -- set to become the world’s youngest female leader even though she didn’t win as many votes as her rival in the Sept. 23 election -- plans to review and reform the Reserve Bank Act, according to a statement on Oct. 24. Her Labour Party said prior to the poll that it wanted the Reserve Bank to add full employment to its mandate.
While Labour doesn’t plan to set a numerical target, Ardern said yesterday she wanted to see the nation’s jobless rate fall below 4 percent from 4.8 percent currently.
"No policy regime should be immune to evolution," said Russell Jones, a London-based partner at the Llewellyn Consulting research group. "It would be foolish blindly to keep doing the same thing, the same way, irrespective of a changing economic and political environment."
Not every one agrees that change is necessary. The idea of requiring the RBNZ to add employment to its mandate is “completely barmy,” said Arthur Grimes, a former chairman of the RBNZ board and one of the architects of the legislation when he was head of economics at the central bank in the late 1980s.
“Why change something when there’s not a problem,” he said in an interview. "If it’s done badly, you could have real swings in policy. It’s an unstable situation.”
One worry is that a diverse mandate can dilute policy makers focus and confuse investors.
"A key characteristic of many successful monetary policy systems is that they are transparent and that agents understand the logic and rationale behind policy decisions," said Tony Cavoli of the University of South Australia. "Having potentially competing goals might possibly undermine this transparency and weaken the effectiveness of monetary policy."
And yet there’s been a growing chorus who argue there’s a need to look beyond inflation targets as prices across much of the world remain subdued. Some, including Claudio Borio at the Bank for International Settlements, have stirred debate by asking whether policy makers should consider even more variables such as asset prices and financial stability. A group of former officials and academics said in a report published on Wednesday that authorities should regularly review their mandates.
Critics of strict inflation targeting have been vocal in Japan, where Bank of Japan Governor Haruhiko Kuroda has unleashed an unprecedented stimulus program that has failed to push inflation even close to its 2 percent target.
Perhaps inflation targeting’s best defense is that no clear alternative framework has emerged and many proposals carry problems of their own. Targeting asset prices, for instance, would beg the question: how can we be so sure central banks will determine when assets are optimally priced any better than markets can?
Yet even inflation-targeting pioneer Grimes concedes there may be scope for central banks to do more to guard against excesses in the financial system.
“The bigger debate is whether one should supplement flexible inflation targeting with a macro prudential role,” he said. “The arguments on that one are finely balanced."
Across the Tasman Sea, tighter lending restrictions by the banking regulator have taken some of the steam out of Australia’s housing market, allowing the RBA to keep interest rates at record lows for more than a year. Governor Philip Lowe, who has said he and the board aren’t "inflation nutters," has fallen back on other parts of his mandate rather than keep cutting rates to meet his inflation goal.
"Having a single minded focus on inflation I think was very useful when inflation was clearly the single most important problem," according to Michael Spencer, global head of economics at Deutsche Bank in Hong Kong. "It’s safe to say that today that is clearly not the case."
— With assistance by Piotr Skolimowski