Home' Trinidad and Tobago Guardian : October 1st 2015 Contents OCTOBER 1 • 2015 www.guardian.co.tt BUSINESS GUARDIAN
THE ECONOMIST | BG23
Sometimes doing nothing really is better than
doing something. On Sept. 17 the Federal Reserve
made the right decision to leave its benchmark
interest rate, unchanged since 2008, near zero.
With inflation sitting well below the Fed s two
per cent target and doubts about China s econ-
omy prevalent, a hike would have been an unnec-
However, Fed chairwoman Janet Yellen will
face a similarly tough choice in October, and
possibly for many months thereafter. Whenever
"liftoff" occurs, financial markets expect rates
to stay historically low for years to come. The
era of unconventional monetary conditions
shows no sign of ending. If the rich world s
central banks are to get back to the normality
they crave, their standard toolkit may not suffice.
It is time to think more boldly, especially about
the idea of inflation targeting.
That is because the usual relationship between
inflation and unemployment appears to have
broken down. In the short run, economists
think, these two variables ought to move in
opposite directions. High joblessness should
weigh on prices, while low unemployment ought
to push up inflation by raising wages.
Unfortunately, in many rich countries this
standard inflation thermostat is on the blink.
In 2008 economic growth collapsed and unem-
ployment soared, but inflation only gradually
sank below target. Now, by contrast, unem-
ployment has fallen to remarkably low levels,
but inflation remains anemic.
This has caught central banks off balance.
Assuming that rising prices would follow hard
on the heels of a job boom, both the Fed and
the Bank of England ended stimulative bond-
buying programs and prepped markets for loom-
ing rate hikes. Their recoveries instead have
proved nearly inflation-free. Worse, with interest
rates close to zero per cent, central bankers have
less room to respond if they misread inflation
risks and tighten too soon. Given this double
bind, it makes sense to look beyond inflation;
and to consider targeting nominal GDP instead.
A target for nominal GDP---the sum of all
money earned in an economy each year, before
accounting for inflation---is less radical than it
sounds. It was a plausible alternative when infla-
tion targets became common in the 1990s.
A target for NGDP growth, ie growth in cash
income, copes better with cheap imports, which
boost growth, but depress prices, pulling today s
central banks in two directions at once. Nominal
income also is more important to debtors eco-
nomic health than either inflation or growth,
because debts are fixed in cash terms.
Critics fret that NGDP is hard to measure,
subject to revision and mind-bogglingly unfa-
miliar to the public. If NGDP sounds off-putting,
though, growth in income does not. Although
inflation can be measured easily enough, central
banks now rely nearly as much on estimates of
labour-market "slack," an impossibly hazy num-
ber.Most important, an NGDP target would free
central banks from the confusion caused by the
broken inflation gauge. To set policy today,
central banks must work out how they think
inflation will respond to falling unemployment,
and markets must guess at their thinking. An
NGDP target would not require the distinction
between forecasts for growth, and hence employ-
ment, and forecasts for inflation.
What might an NGDP target mean in practice?
Most economies have fallen well short of their
pre-recession trend in nominal-income growth.
Before the financial crisis, NGDP growth of five
per cent was considered normal in America.
Today, though, the economy is 16 per cent below
the income threshold it would have reached had
it grown at that pace since 2006. In Britain,
too, NGDP is 15 per cent short of where it could
have been. The euro zone and Japan are even
Such shortfalls are too great to make up quick-
ly, because to do so would imply dangerously
high inflation rates. Even relative to recent trends,
however, rich economies are coming up short.
American NGDP is five per cent below what
you might have anticipated in 2010. Faster NGDP
growth could come from better productivity,
more hiring or faster inflation --- all of which
rich economies could use a bit more of.
Setting a different target does not mean that
central banks will automatically reach it. Their
unconventional toolkit looks depleted, however.
Quantitative easing, which still is in use in Europe
and Japan, is falling out of favor because of wor-
ries about asset prices. Interest rates cannot be
cut far below zero without radical changes in
the nature of money; the Bank of England s
chief economist recently suggested eliminating
Getting the target right is an important start,
though. Patiently waiting for inflation to turn
up is no longer good enough.
Central Banking: Time for a new target
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