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.


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