Things to think about #1
Why are central banks targeting 2% inflation, and should they?
This question seems to be on a lot of people’s minds at the moment, as it should given the likely difficulty in an achieving a perfect landing in inflation at 2%. Bloomberg’s Marcus Ashworth even asks the question that I suspect many economists or investors are thinking about at the moment; should the 2% inflation target be retired? And if so, how?
Starting with the why, the story goes that the Reserve Bank of New Zealand and the Bank of Canada were early adopters of explicit inflation targeting in the early 1990s, and that their decisions were subsequently influential in shaping monetary policy elsewhere. RBNZ was the first central bank to adopt an explicit inflation targeting regime. This shift occurred in 1990, influenced by the country's experiences with high inflation during the 1970s and 1980s. The decision was part of broader economic reforms aimed at stabilizing the economy and improving economic performance. In 1989, the Reserve Bank of New Zealand Act was passed, which redefined the role and responsibilities of the RBNZ. The Act gave the central bank a primary objective of achieving and maintaining price stability. In 1990, the RBNZ announced its first specific inflation target, initially set at a range of 0% to 2%. This target was later adjusted, but the commitment to maintain inflation within a specific range has remained a cornerstone of New Zealand's monetary policy. In the US, a new paper by the Richmond Fed discusses the origins of the 2% inflation target for the Fed.
The discussion of whether there is any slippage in the 2% target—there probably is— and how/whether central banks will apply it remains key to the ability of policymakers to engineer a soft landing, or more aptly, to avoid a hard landing if they go searching for 2% at all costs. If, as I suspect, developed economies and their central banks are unlikely to achieve a perfect landing for inflation at 2%, what will central banks do? The good news is that the difference, in terms of underlying stability in growth, employment and inflation expectations, need not be dramatically different between an economy with inflation at 2% and one with inflation at 3%. But initial conditions matter. An explicit shift in the inflation target, from say 2% to 3%, is risky because it could send inflation expectations soaring, as markets invariably speculate that any initial change in the inflation target will lead to further shifts down the line.
The counterpoint, if inflation is sticky around 2-to-3%, is what central banks with a formal inflation target need to do? Don Kohn, the director of the monetary affairs division at the Fed during the early discussions about inflation-targeting at Greenspan’s Fed hits the nail on the head:
“If you make 2 percent public, and you’re running at 2.5 percent, then the question is, ‘why aren’t you creating unemployment to get to 2 percent?’ That’s not a position anyone really wanted to be in.”
Richmond Fed Q1 2024, P. 11
What is most interesting in the Richmond Fed’s description about the evolution of inflation targeting in the US is that it started as an implicit target, mainly because Fed officials were worried about nailing their colours to the mast on a number. History has since evolved in a way to produce explicit 2% targets in almost all developed market central banks, but does it have to be so?
Assuming for a moment, that central banks are able to make a transition towards either a 2% inflation target with wiggle-room, or a more implicit commitment to “low inflation” and “price stability” what will this look like? What pace of inflation above 2% will central banks, the economy and markets be able to live with in a stable equilibrium? 2.5%, 3.0%? No one knows, but I suspect we’ll soon have to come up with an answer to this question. For a more theoretical treatment of this topic by me here and here.
The allure of Nostalgia
Charlie Tyson offers an interesting perspective on nostalgia and its uses in the most recent print-edition of the Hedgehog Review, reflecting on Tobias Becker’s new book;Yesterday: A New History of Nostalgia.
Charlie sets the scene by kicking nostalgia while it is down;
Nostalgia is a debased emotion. Intellectuals scorn it; corporations exploit it. Therapists instruct us to live in the present moment. Yet only the most austere and bloodless temperaments seem immune to the lure of times gone by. All the same, this sentimental yearning for an irrecoverable past is widely dismissed as regressive and reactionary. When we give in to nostalgia, we do not simply remember the past. We distort it, idealizing and whitewashing whatever lost era we wistfully recall. In projecting our desires onto the past, we bury historical reality—and the many forgotten people who lived, suffered, ate, had sex—in clouds of perfumed mist.
He then goes on to describe Becker’s book—which I have not read in fairness—as an attempt to restore the reputation and relevance of nostalgia, by criticising the way nostalgia is either seen as a “pejorative” or something to be used opportunistically by politicians on either side of the political spectrum. Charlie concludes:
At a sufficiently distant remove, [nostalgia’s] glow can illuminate ideals for more humane living. And for the multitudes of people who are victims, rather than agents, of historical change, nostalgia can offer a partial escape when all other routes have been blocked. (…) Nostalgia greets us when we are most desperate. A way of coping with a present that is no longer habitable, it provides, in the end, a last resort.
I have a lukewarm relationship with nostalgia as described above. I can see why it offers an escape from the toils of the present, and even in some cases a productive one. Mostly, however, I see nostalgia in our times as described by Charlie, a coping mechanism in the face of an insane version of progressivism touting anything from identity politics to euthanasia and assisted dying to tackle climate change and the “burden” on society from elderly and ill people unable to take care of themselves. But reaching for such an easily accessible way to deal with a warped present also brings stasis and defensiveness. After all, the river of time, as best we know, flows forward, not backward. Anyone struggling with their present reality will be able to find solace and comfort in nostalgia, but only if such comfort is used as inspiration to form new ideas can they hope to extract themselves from their mire. As for nostalgia then; use when applicable, but sparingly.