Inflation Targeting and Neoliberalism, Part 2

Regular Triple Crisis contributor Gerald Epstein is a professor of economics and a founding co-director of the Political Economy Research Institute (PERI) at the University of Massachusetts-Amherst. This is the second part of an interview in which he discusses the rise of “inflation targeting” around the world. The first part is available here.

Alejandro Reuss: Hasn’t it been a central concern on the part of elites in capitalist countries, at least in those where there is representative government, that the majority could impose its will and force policymaker to prioritize full employment and wage growth (as opposed to, say, “sound money”)? Has the transition toward inflation targeting been accompanied by institutional changes to “wall off” monetary policy from those kinds of popular pressures?

Gerald Epstein: Yeah, I think that’s a very important point here. Inflation targeting ideas have also been often accompanied by the idea that central banks should be “independent”—that is, independent from the government. I think you’ll find that these two things go hand-in-hand. If you look at the whole list of central bank rules that the International Monetary Fund (IMF) and others have advocated for developing countries, the argument goes like this: You want to have an independent central bank. Well, what should this independent central-bank do?It should target inflation. Well, isn’t this anti-democratic? No, what we’re really saying is that central bankers should have instrument independence, that is, the ability to decide how they’ll achieve their target, The government should set the target, but what should target be? Well, the consensus is that the target should be a low rate of inflation. So that’s a nice little package designed to prevent the central bank from doing such things as helping to finance government infrastructure investment or government deficits. It’s designed to prevent the central bank from keeping interest rates “too low,” which might actually contribute to more rapid economic growth or more productivity growth, but might lead to somewhat higher inflation.

Where do they get this low inflation rate from? There’s no economic evidence, in fact—and there have been lots of studies—to demonstrate that an inflation rate in the low single digits is optimal for economic growth in most countries, certainly not in developing countries. Some early studies—and this has been replicated many times—have suggested that inflation rates of up to 15%, even 20%, as long as they’re relatively steady, don’t harm economic growth. They might even contribute to it. So this is a kind of straitjacket that these forces are trying to put the central bank in, in order to prevent them from making policies in the interest of a broader part of the economy. And it’s just one plank in the macroeconomic neoliberal straitjacket. The other plank, of course, is no fiscal deficits. So you limit what government can do—no fiscal deficits or low fiscal deficits—you limit what the central bank can do—only target low inflation—and you’ve pretty much made it impossible for the government to engage in macroeconomic policy that’s going to have a broad-based supportive effect on the economy.

AR: What is the record of inflation targeting policy in practice, in terms of economic outcomes we can actually observe, in both developing and so-called developed countries?

GE: The first thing to realize, I think, is that inflation-targeting approaches have been devastating in the reaction to the financial crisis of 2007-2008, particularly in Europe. There you had, an extreme case where the European Central Bank (ECB) mandate was to target inflation—period—and nothing else. And indeed to keep inflation in the low single digits, less than 2%. And what this did was—along with other rules, other problems in Europe, not just this—what this did was give the ECB the cover to do very little in terms of fighting the crisis when it hit, to in fact raise interest rates within the first year after the crisis hit. And it took the ECB several years before it finally realized the disaster that had befallen Europe and, when Mario Draghi finally came in as president of the ECB in 2011, to do whatever it takes to keep the euro going. It took a break from this kind of orthodoxy for them to begin to turn around Europe. (As we can now see Europe is still in terrible shape.)

Second, the single-minded focus on inflation in Europe and in other countries made them ignore the financial bubble, the asset bubbles that were occurring. Central bankers said, “Well, you know, that’s not my department. I’ll just worry about commodity inflation. I won’t worry about other kinds of inflation because that’s not my mandate.” They had this tunnel vision, not seeing what else was going on around them in the economy.

In developing countries, there’s pretty strong evidence that real interest rates have been higher than they would have been otherwise. There’s some evidence of economic growth is lower in a number of developing countries than it would have been otherwise, because real interest rates have been so high. And there is some evidence that this has contributed to a redistribution of income towards the rentiers, that is, to the bankers and the financiers, and away from others because real interest rates have been so high and inflation has been relatively low. Most of the evidence suggests that it is had a negative consequence for working people and others in developing countries as well.

In the end, the negative impacts have been mitigated to some extent by the fact that a lot of central banks, in developing countries particularly, claim to be following a very strict inflation-targeting regime but in fact they’ve been “cheating.” Almost all of them target exchange rates to some extent because they know they can’t let their exchange rates get too overvalued or otherwise that is going to hurt their exports and cause other problems. They’ve been fiddling with the inflation data, or exactly what kind of inflation target they use, etc. In some ways it’s a bit of a ruse. For developing countries, it’s saying to the IMF, “OK, we’re doing what you’re telling us.” Saying to the global financial markets, to the global investors, “OK we’re doing this orthodox thing, but (wink wink) if we really did this all the time in a strict way it would be suicide so we’re not going to really do this completely.” So they’re finally is a recognition, I think, that inflation targeting is a very destructive practice.

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