Inflation targeting in a period of global disinflation


The IMF, in its October 2016 World Economic Outlook (WEO), has documented the spread and scope of global disinflation since the global recession of 2008-2009. As it notes:

By 2015, inflation rates in more than 85 percent of a broad sample of more than 120 economies were below long-term expectations, and about 20 percent were in deflation—that is, facing a fall in the aggregate price level for goods and services.

The Fund attributes this to a combination of economic slack and soft commodity prices.

Global disinflation has important implications for the inflation targeting framework (ITF) that has dominated the design and conduct of monetary policy in recent decades, at least in the advanced economies. It appears that ITF was good in taming inflation, but has so far proven to be insufficiently effective in dealing with disinflation. Yet, central bankers in the systemically important nations of the world have not given up on ITF, continuing to persist with so-called quantitative easing and forward guidance. Leading economists worry that monetary policy has run out of ammunition to deal with global disinflation despite even negative interest rate policy in the case of some countries. Larry Summers fears that there is an

Overwhelming likelihood that there will be downturns in the industrial world sometime in the next several years. Nowhere is there room to cut rates by anything like the normal 400 basis points in response to potential recession. This is the primary monetary and indeed macroeconomic policy challenge of our generation.

Yet, central bankers – or at least the most influential ones – are wedded to a framework that was the product of a specific historical period and designed to tame high inflation. One wonders whether they are like generals fighting the proverbial last war.


Inflation targeting in the developing world: a minority policy regime?

In 1990, the central bank of New Zealand became the first country in the world to adopt an inflation targeting (IT) regime. Two years later, the founding members of the Eurozone adopted the Maastricht Treaty that included an inflation target along with fiscal rules. Other countries – such as Australia, Canada, UK and Sweden – became IT regimes between 1991 and 1993.  Low and middle-income countries followed with a significant lag, usually about 10 years.  By 2014, the IMF calculates that there were 34 IT regimes in the world in addition to all the countries that belong to the Eurozone and fall under the European Central Bank (ECB) which practices inflation targeting. The spread of IT regimes to the developing world has been rather limited . There are only 19 out of more than 90 middle-income economies and only one out of 31 low-income that can be classified as IT regimes – even on a de facto basis.

Monetary policy in the advanced economies has emerged as the preferred tool of short-run economic stabilization, while fiscal policy has primarily been assigned to deal with debts and deficits. This is a paradigm shift from the golden age of Keynesian economics when both monetary and fiscal policy shared the responsibility of short-run economic stabilization in the pursuit of the twin goals of price stability and full employment. It was also the period in which discretion rather than rules governed the conduct of macroeconomic policy. This has evolved into a distinct preference for rules and targets rather than discretion – or at least discretion constrained by the need to observe rules and targets.

In the case of low and middle-income countries, the spread and scope of IT has been rather limited despite the formidable intellectual and political influence of both academics and practitioners preaching the virtues of IT regimes. This is not necessarily an undesirable outcome. The institutional prerequisites for the successful conduct of an IT regime are not always in place in the developing world – such as the effective transmission of monetary policy, especially in low-income countries. More importantly, following the global recession of 2008-2009, IT regimes in developed countries have faltered significantly in terms of their effectiveness. Furthermore, an ideological allegiance to a particular framework in which monetary policy is given primacy over fiscal policy has constrained the capacity of macroeconomic policy managers in the advanced economies to use fiscal initiatives to kick-start growth in the wake of the global recession of 2008-2009. This in turn has prolonged the period of slow growth in the developed world. Such lacklustre growth in the rich nations has acted as a drag on global growth.

There are thus important lessons that low and middle-income economies can learn from the experience of IT regimes in the developed world. What one learns in particular is that the objective of low inflation needs to be combined with other development objectives. If IT regimes constrain, rather than empower, central banks in low and middle-income economies to pursue growth and employment objectives that are at the core of the development process, then there is a case for re-thinking the appropriate role of central banks without sacrificing their obligations with respect to price stability.


The IMF and fiscal consolidation: a case of business as usual ?

Three leading IMF economists (Jonathan Ostry, Prakash Lougani, Davide Furceri ,2016) offer the following refreshing thoughts on fiscal austerity as part of a general critique of neoliberalism:[1]

Austerity policies … generate substantial welfare costs …and worsen employment and unemployment. The notion that fiscal consolidations can be expansionary (that is, raise output and employment), in part by raising private sector confidence and investment, has been championed by, among others, Harvard economist Alberto Alesina in the academic world and by former European Central Bank President Jean-Claude Trichet in the policy arena. However, in practice, episodes of fiscal consolidation have been followed, on average, by drops rather than by expansions in output. On average, a consolidation of 1 percent of GDP increases the long-term unemployment rate by 0.6 percentage point and raises by 1.5 percent within five years the Gini measure of income inequality … In sum, the benefits of some policies that are an important part of the neoliberal agenda appear to have been somewhat overplayed….In the case of fiscal consolidation, the short-run costs in terms of lower output and welfare and higher unemployment have been underplayed, and the desirability for countries with ample fiscal space of simply living with high debt and allowing debt ratios to decline organically through growth is underappreciated.

So far, so sound. But…what has the IMF proffered in practice through its bilateral surveillance advisory services that are typically channelled via the Article IV consultations? Brad Setser from the Council on Foreign Relations thinks that there is a disconnect between what the Fund preaches – or least some of its more progressive voices do – and what it practices in operational terms. He notes:

…the Fund is advocating a 2017 fiscal consolidation for the euro zone, as the consolidation the Fund advocates in France, Italy, and Spain would overwhelm the modest fiscal expansion the Fund proposed in the Netherlands (The IMF is recommending that Germany stay on the fiscal sidelines in 2017).

The same seems to be true in East Asia’s main surplus economies (China, Japan, Korea)…[2]

A 2016 ILO study – which I happened to supervise – found that in more than 90 out of 100 low and middle-income economies, the IMF Article IV consultations recommended fiscal consolidation. [3]








Michael Kalecki on market confidence

The notion of ‘market confidence’ is perhaps the intellectual bedrock on which the agenda of economic conservatism rests. It can be invoked to justify fiscal austerity, privatization, labour market deregulation and so forth. The late Michael Kalecki, an eminent Marxist economist, offers one of the most prescient pronouncements on ‘market confidence’ and the role that it plays in shaping economic policy …[1]

  Under a laissez-faire system the level of employment depends to a great extent on the so-called state of confidence.  If this deteriorates, private investment declines, which results in a fall of output and employment (both directly and through the secondary effect of the fall in incomes upon consumption and investment).  This gives the capitalists a powerful indirect control over government policy: everything which may shake the state of confidence must be carefully avoided because it would cause an economic crisis.  But once the government learns the trick of increasing employment by its own purchases, this powerful controlling device loses its effectiveness.  Hence budget deficits necessary to carry out government intervention must be regarded as perilous.  The social function of the doctrine of ‘sound finance’ is to make the level of employment dependent on the state of confidence.





Women on Boards: The Glass Ceiling?

In the most of developed Western democracies, women and men are present  side by side in politics, government, sports and business.  Australia is far behind in terms giving equal share to women, at least in politics and business. Women comprise 46 per cent of all employees in Australia. But they hold only 14.2 per cent of board chairs, 23.6 per cent of directorships, and 15.4 per cent of CEO roles. Although  there have been recent calls for putting more women in corporate boards and  there had been at least one attempt to introduce a bill requiring more women  on corporate boards, only time will tell how far we can go. Is it the “glass ceiling”? Is it the “competency gap”? Or what?

One is a token, two is a presence, three females on a board is a voice.