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. In early May, he sat down with Triple Crisis co-editor Alejandro Reuss to discuss the rise of “inflation targeting”—the emphasis on very low inflation, to the exclusion of other policy objectives, in central bank policy-making—around the world. This is the first of three parts.
Alejandro Reuss: When we talk about central banks and monetary policy, what precisely is meant by the phrase “inflation targeting”? And how does that differ from other kinds of objectives that central banks might have?
Gerald Epstein: Inflation targeting is a relatively new but very widespread approach to central bank policy. It means that the central bank should target a rate of inflation—sometimes it’s a range, not one particular number, but a pretty narrow range—and that should be its only target. It should use its instruments—usually a short-term interest rate—to achieve that target and it should avoid using monetary policy to do anything else.
So what are some of the other things that central banks have done besides try to meet an inflation target? Well, the United States Federal Reserve, for example, has a mandate to reach two targets—the so-called “dual mandate”—one is a stable price level, which is the same as an inflation target, and the other is high employment. So this is a dual mandate. After the financial crisis there’s a third presumption, that the Federal Reserve will look at financial stability as well. Other central banks historically have tried to promote exports by targeting a cheap exchange rate. Some people have accused the Chinese government of doing this but many other developing countries have targeted an exchange rate to keep an undervalued exchange rate and promote exports. Other countries have tried to promote broad-based development by supporting government policy. So there’s a whole range of targets that, historically, central banks have used.
AR: Has inflation targeting gone hand-in-hand not only with prioritizing price stability over other kinds of objectives, but also with an emphasis on very low rates of inflation?
GE: That’s right. In practice, what inflation-targeting advocates have argued for is an extremely low rate of inflation. For example, the European Central Bank has a 2% target, or to keep inflation in fact just below 2%, and typically what is called for is inflation in the low single digits. In developing countries, targets have ranged from 4% to 8%. So these are targets for inflation that are very low compared to broad historical experience. These days, very low inflation and indeed the threat of deflation in some countries have raised all kinds of issues about this inflation targeting approach.
I see this as part of a whole neoliberal approach to central banking. That is, the idea that the economy is inherently stable, it will inherently reach full employment and stable economic growth on its own, and so the only thing that the macro policymakers have to worry about is keeping a low inflation rate and everything else will take care of itself. Of course, as we’ve seen, this whole neoliberal approach to macroeconomic policy is badly mistaken.
AR: Why have we seen inflation targeting become more prevalent in monetary policy making, both in high-income and lower-income countries, in recent years? What are the key arguments that are made by advocates of inflation targeting in favor of that approach? And what might be some underlying political and economic causes, even apart from those arguments.
GE: It’s been a real revolution in central bank policy and, as I said earlier, it’s in my view part and parcel of the whole neoliberal trend in macroeconomic policy. The essential thing underlying this, in my view, is to try to reduce the power of government and social forces that might exercise some power within the political economy—workers and peasants and others—and put the power primarily in the hands of those dominating in the markets. That’s often the financial system, the banks, but also other elites. The idea of neoliberal economists and policymakers being that you don’t want the government getting too involved in macroeconomic policy. You don’t want them promoting too much employment because that might lead to a raise in wages and, in turn, to a reduction in the profit share of the national income. So, sure, this might increase inflation, but inflation is not really the key issue here. The problem, in their view, is letting the central bank support other kinds of policies that are going to enhance the power of workers, people who work in agricultural areas, and even sometimes manufacturing interests. Instead, they want to put power in the hands of those who dominate the markets, often the financial elites.
That is, of course, not what the advocates of inflation targeting say publicly. What the advocates say is, “Look, inflation is harmful. We’ve got to keep a low and stable rate of inflation in order to promote economic growth.” They build on the neoclassical, New Keynesian, or even New Classical approaches to macroeconomic policy that say the market economy a stable in and of itself, so government intervention can only mess things up. So there’s only one thing left to do—there’s only one thing on the “to do” list for macroeconomic policy—and that is to keep a stable inflation rate, so let’s assign the central bank to do that and not to do anything else, and the capitalist economy will take care of itself.
This approach, I think, really has contributed to enormous financial instability. Notice that this inflation targeting targets commodity inflation. But what about asset bubbles, that is, asset inflation? There’s no attempt to reduce asset bubbles like we had in subprime or in real estate bubbles in various countries. That is another kind of inflation that could have been targeted.
Of course, we know that the capitalist economy does not achieve full employment on its own. So why not target higher employment? In South Africa, for example, they have unemployment rates of 25 or 26%. They have an inflation-targeting regime to keep inflation in the low single digits, rather than targeting employment. It makes no sense at all.
The other argument that inflation-targeting advocates make is a government failure argument. Even if you concede that the economy won’t do perfectly on its own, any time the government gets involved in the market economy they just mess it up. So, they argue, let’s just have a minimalist kind of government intervention and at least the government will do no harm. I think this is a common argument as well. But as we know, there have been many successful government interventions in South Korea and China and elsewhere where governments working with a financial system and other actors in the economy have played a crucial role in economic development. The government-failure arguments, I think, have now been shown to be pretty fallacious. Olivier Blanchard, who was the chief economist at the IMF said we had this beautiful illusion that all we needed is one target, that is low inflation, and one interest rate, that is a short-term interest-rate, and everything would be OK. Well, after the crisis, we now know that we need multiple targets and we need multiple tools to achieve our goals.
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