The Federal Reserve may stop targeting inflation, the measure of price increases for goods and services over time, as the coronavirus response threatens economic depression a la the 1930s.
The Great Lockdown has led to 26.4 million jobless claims in the U.S. through April 18; that’s a record. And, unprocessed claims may push that number closer to 40%. Either way, job losses amid the crisis have wiped out all of the job gains since the Great Recession.
Pushan Dutt, professor of Economics and Political Science at INSEAD, says central banks will need to shift policies. “…[T]hey have put a lot of weight on inflation — they are much less worried about unemployment,” he said. “The next generation of central bankers who take over would have grown up during the global financial crisis and the Covid-19 pandemic. These central bankers will put, in my opinion, more weight on reducing unemployment and they will worry far less about inflation.” This includes the Bank of England, the European Central Bank or the Federal Reserve.
Heretofore, central banks such as European Central Bank, U.S. Federal Reserve, Federal Bank of Australia, and Bank of England develop target inflation rates in the their monetary policy. But, Joseph Gagnon, senior fellow at the Peterson Institute for International Economics (PIIE), also believes that bankers will instead target employment rates, though he believes this will likely happen first outside of the United States.
“For the Fed, employment has always been an equal goal to inflation — so that won’t change,” he told CNBC. “But I think it might change elsewhere where employment hasn’t had the same status. And it should change, frankly, because I think they’re actually both equally important goals for central banks.”
Gabriel Sterne, head of global strategy services and emerging markets macro research at Oxford Economics, said the Covid-19 crisis would “almost certainly” shift focus from price inflation targets. “I think coronavirus will definitely have a big impact on inflation and views towards policy — I think it could tip the monetary frameworks over the edge,” he told CNBC. “Most central banks do inflation targeting, but the problem with inflation targets is that they are both too high and too low.” He says in many markets central bankers had failed to successfully meet their inflation targets, anyway.
“If you have monetary policy trying to hit inflation at 2%, what we’ve seen is central banks just failing to do it, because they haven’t got enough space on the downside,” Sterne said. “Imagine if inflation was on average 4% and interest rates on average were 4% — that would mean when you get a nasty shock, you can lower interest rates and you wouldn’t get to zero and think ‘oh, my goodness, we can’t lower interest rates anymore,’ which is where all central banks are now.”
Sterne added: “The point is, inflation targets just aren’t fit for purpose at the moment. I think the credibility of inflation targeting regimes is really low at the moment, as low as it ever has been, to the point where they’re pretty redundant. Financial markets have been way better at predicting inflation than central banks are. I think the whole framework now has lower credibility internationally than it has since inflation targets were started in the early 90s.” The crisis would make it more difficult to meet inflation targets, he said.