Financial Times Editorial - A well-timed warning
Financial Times Editorial - A well-timed warning
Copyright The Financial Times Limited 2006
Published: June 28 2006 03:00 | Last updated: June 28 2006 03:00
The central bankers' bank does not talk lightly about inflationary pressures. So when the Bank for International Settlements publicly cautions that central banks may need to raise interest rates more quickly, to head off inflation, it must be taken seriously.
The BIS has been brave in opening up this subject in its annual report, and should be applauded for doing so. It has made a timely call for banks to continue tightening monetary policy - as the US Federal Reserve is expected to do tomorrow with a further 0.25 percentage point rise.
The BIS has also set out a challenge to conventional wisdom, in suggesting that central banks should adjust their thinking about how they set interest rates. Sometimes, it says, it may be better to raise interest rates even if inflation falls below desired levels, provided this avoids deeper undershooting of the inflation target later on.
It is easy to agree that there is more to good economic policy than hitting an inflation target precisely. It is harder to argue that monetary policy should attempt to address other objectives. Strictly speaking, any one instrument can only hit one target.
Moreover, even if one accepts that the recent extended period of low interest rates fuelled a surge in global asset prices and current account imbalances, one should not conclude that central bankers ought to have behaved in a radically different fashion.
First, the long period of stability in inflation and growing output that large parts of the world have enjoyed suggests that central bankers were not disastrously mistaken. A global recession - which was a distinct possibility - would have been a much clearer signal that they had set interest rates at the wrong levels. Second, attempting to target asset prices is extremely hard, for the simple reason that nobody can be sure what the right level is at any particular moment.
This example of the limits of our economic knowledge is one reason for reservations about adopting the more flexible framework the BIS recommends. Central banks should indeed have a lengthy time horizon in making decisions. They should also, as Alan Greenspan, the former chairman of the Federal Reserve, used to argue, adopt a "risk management" approach. But they must not endanger control over inflation. Not only might they make serious mistakes if they did so, but they would risk confusing markets, as well.
That said, there is some scope for them to lean against the wind. If asset prices are soaring to extraordinary heights, but inflation remains under control, it may make sense for central banks to operate a tighter monetary policy than in normal circumstances.
Politicians have handed monetary policy to central bankers, rather than computers. They must, in turn, exercise judgment about the risks ahead. If this leads to modest deviations of inflation from the objective, so be it.
Copyright The Financial Times Limited 2006
Published: June 28 2006 03:00 | Last updated: June 28 2006 03:00
The central bankers' bank does not talk lightly about inflationary pressures. So when the Bank for International Settlements publicly cautions that central banks may need to raise interest rates more quickly, to head off inflation, it must be taken seriously.
The BIS has been brave in opening up this subject in its annual report, and should be applauded for doing so. It has made a timely call for banks to continue tightening monetary policy - as the US Federal Reserve is expected to do tomorrow with a further 0.25 percentage point rise.
The BIS has also set out a challenge to conventional wisdom, in suggesting that central banks should adjust their thinking about how they set interest rates. Sometimes, it says, it may be better to raise interest rates even if inflation falls below desired levels, provided this avoids deeper undershooting of the inflation target later on.
It is easy to agree that there is more to good economic policy than hitting an inflation target precisely. It is harder to argue that monetary policy should attempt to address other objectives. Strictly speaking, any one instrument can only hit one target.
Moreover, even if one accepts that the recent extended period of low interest rates fuelled a surge in global asset prices and current account imbalances, one should not conclude that central bankers ought to have behaved in a radically different fashion.
First, the long period of stability in inflation and growing output that large parts of the world have enjoyed suggests that central bankers were not disastrously mistaken. A global recession - which was a distinct possibility - would have been a much clearer signal that they had set interest rates at the wrong levels. Second, attempting to target asset prices is extremely hard, for the simple reason that nobody can be sure what the right level is at any particular moment.
This example of the limits of our economic knowledge is one reason for reservations about adopting the more flexible framework the BIS recommends. Central banks should indeed have a lengthy time horizon in making decisions. They should also, as Alan Greenspan, the former chairman of the Federal Reserve, used to argue, adopt a "risk management" approach. But they must not endanger control over inflation. Not only might they make serious mistakes if they did so, but they would risk confusing markets, as well.
That said, there is some scope for them to lean against the wind. If asset prices are soaring to extraordinary heights, but inflation remains under control, it may make sense for central banks to operate a tighter monetary policy than in normal circumstances.
Politicians have handed monetary policy to central bankers, rather than computers. They must, in turn, exercise judgment about the risks ahead. If this leads to modest deviations of inflation from the objective, so be it.
posted by Carlos T Mock at 3:12 PM
0 Comments:
Post a Comment
<< Home