Inside the world’s oldest central bank, a new debate is raging over a dilemma facing monetary authorities around the globe. Policymakers at Sweden’s 344-year-old Riksbank and elsewhere are arguing about how far they can look beyond their mandates to stabilise prices 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 only 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, the chief economist at HSBC in London and a former UK 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 Svensson, who once taught economics alongside US Federal Reserve chairman Ben Bernanke at Princeton University, says keeping inflation too low hurts hiring, while governor Stefan Ingves has said he was worried about a debt bubble arising from low interest rates. The Riksbank left its benchmark rate unchanged at 1.25 percent in October.
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 (ECB) faces internal criticism for proposing to buy bonds of cash-strapped nations. The rejection by the Bank of Japan of more radical policy in a period of moderate deflation has become a key political debate ahead of Sunday’s Japanese 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 emphasising 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 programme in September to purchase $40 billion (R347bn) in mortgage-backed securities a month. The buying – which probably will push the Fed’s balance sheet beyond $3 trillion – would stop only when the labour market improved “substantially”, the Fed said.
Unemployment was 7.7 percent last month compared with 4.7 percent before the 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 was not 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 will probably follow the Fed’s embrace of more stimulus next year, according to Nathan Sheets, the New York-based global head of international economics at Citigroup. The US banking giant 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,” Sheets, Bernanke’s top adviser on international economies from 2007 to 2011, said in a November 26 report.
With interest rates in major economies near zero and quantitative easing facing diminishing returns, policymakers may consider fresh unorthodox tools, according to Société Générale economists. The Bank of England is already 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”, according to Allen Sinai, the chief global economist at Decision Economics.
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 US, 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 in 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 that central bankers are taking on, or at least talking about, broader objectives. Mark Zandi, the chief economist at Moody’s Analytics, said they were more confident in their understanding of how inflation worked after years of trying to control it and now had a track record of capping expectations, which had “bought them room to be aggressive in other ways. They worked for a quarter century to gain credibility, and they should use it.”
Sheets said central banks could not maintain political credibility by focusing only on low inflation amid high unemployment and weak growth; they existed because their legislatures wanted them to be partners in economic prosperity.
In Japan, Shinzo Abe, the head of the opposition Liberal Democratic Party (LDP) who is leading in polls to be the next prime minister, has criticised the central bank for failing to escape deflation and said he wanted “unlimited easing” until the country achieved 2 percent inflation.
Japanese consumer prices excluding fresh food fell in five of the six months to October, and the LDP’s manifesto says it may legislate to increase co-operation between the government and the central bank.
In a November 29 debate, Abe said: “We want to push ahead with anti-deflationary policies on a new level.” His call for “bold monetary easing” helped push the yen to a seven-month low to the dollar last month.
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 UK economy this year fell into its first double-dip recession since the 1970s and unemployment has sat above 7.5 percent since May 2009.
The UK central bank has held its benchmark rate at a record low 0.5 percent since March 2009 and bought £375bn (R5.2 trillion) of assets. It has argued that trying to bring inflation back to the target too quickly could lead to economic pain.
UK Business Secretary Vince Cable told the Observer newspaper on Monday that he would like the Bank of England to have a more explicit target to bolster expansion.
While governor Mervyn King said in an October speech that it was “too soon to bury” the concept of inflation targeting, he added that it was sometimes “justified to aim off” the goal to moderate the risk of financial crises.
Central bankers do have constraints. Some Fed officials have said their soaring balance sheet meant selling the assets would be difficult when the time came to exit. Norway’s central bank governor Oeystein Olsen signalled in September that policymakers were struggling to reconcile a potential housing bubble with low inflation and exporter demands for rate cuts to cool krone gains.
Concerns about a build-up of household debt were restraining the Riksbank from cutting its benchmark repo rate further, governor Ingves said.
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 was “unprecedented”, said Larry Hatheway, the chief economist at UBS in London. “It does seem to move beyond what we’ve envisaged central banks are mandated to do.”
Spanish President Mario Draghi said the purchases would 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 meshed with the goal of ensuring price stability.
With the euro zone economy in recession and unemployment at a record 11.7 percent, the ECB forecast last week that inflation would 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 zone countries”, Draghi said on October 24 in Berlin. So bond purchases under the ECB’s outright monetary transactions programme “are not in contradiction to our mandate; in fact, they are essential for ensuring we can continue to achieve it”.
Bundesbank president Jens Weidmann has been alone on the council in voting against the bond-buying strategy, on the grounds that it is tantamount to printing money to finance governments, which the ECB’s founding treaty prohibits.
Manoj Pradhan, a global economist at Morgan Stanley, said traditional inflation-targeting regimes might be outdated, given the need of consumers, companies and governments to reduce debt. Focusing 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. – Bloomberg