Inflation Targeting and Neoliberalism

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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. Originally published at Triple Crisis

Part 1

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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  1. MikeNY

    Beef has often pointed out that to the CBs, wage inflation is absolutely verboten, can’t have a whiff of that, but asset inflation is the bee’s knees. In fact, it’s the CB’s prime policy tool. That’s too important to be left to Mr Market. CEO and hedge fund manager compensation inflation is also da bomb.

    Because oligarchs.

    1. craazyboy

      Also, how would the Fed target higher employment? Not use the Phillips curve, I hope. Mr. Phillips hires Chinese and Mexican guys nowadays, and he’s a real cheap ass when it comes time to ask for a raise.

  2. Steve H.

    – But what about asset bubbles, that is, asset inflation?

    and again

    – But what about asset bubbles, that is, asset inflation?

    1. barni11

      Asset inflation in a modern democracy means that middle class assets – mainly housing – when responding to increased demand is good; consumer price inflation on the other hand is when corporations increase prices to give corporate owners greater profits while workers incomes stagnate or are driven lower – is bad.
      When employment is falling assets suffer price deflation or stagnation which is bad for the middle/working class families but great for wealthy elites who can buy cheap assets from income insecure middle class families. These assets are then ‘rented’ back to middle class families at high prices. The “rentier economy” then works to create a two class social structure with a small number of very wealthy and a growing number of poorer and more insecure families falling into poverty from middle class.

  3. Nick

    Fascinating read. This is the argument that essentially everyone that I talk to (mostly neoliberals) makes when the topic of higher wages comes up: that that will lead to inflation, which is the root of all evil. By sheer coincindence, that is only ever said by people who are in a position to negotiate their own wages up on a regular basis.

    I’ve suggested having multiple key interest rates: one governing bubble-prone assets like real estate and one for everyday purchases.

    Or just have a revolution and replace market capitalism with libertarian socialism…

  4. dcb

    I believe his comment riht away that we have historic low inflation has been proven tnot to be correct, hen you make a statement as fack, right up front that’s wrong, you screw your entire position

    Investors have often talked about the global economy since the crisis as reflecting a “new normal” of slow growth and low inflation. But, just maybe, we have really returned to the old normal.

    “Very low rates have often persisted for decades upon decades, pretty much whenever inflation is quiescent, as it is now. The interest rate on a 10-year Treasury note was below 4 percent every year from 1876 to 1919, then again from 1924 to 1958. The record is even clearer in Britain, where long-term rates were under 4 percent for nearly a century straight, from 1820 until the onset of World War I.”

    10 year rolling UK inflation 1512 to current

    1. Jim Haygood

      ‘So these are targets for inflation that are very low compared to broad historical experience.’

      As your long series for the UK illustrates, there was no long-term inflation trend until the world went “full fiat” in the 20th century.

      Inflation targeting is a non-issue with a metallic standard. When inflation is done by a committee, then rules are needed to keep the lads from going overboard … just as an airplane whose design doesn’t offer inherent aerodynamic stability requires constant trim correction by microprocessor controls. It’s a kludge, but it can be made to work … until something unusual happens.

      Inflation is the very definition of financial instability. Manipulating the monetary unit to manage the economy — e.g., to boost employment as suggested in the penultimate paragraph above — gave G7 countries inflation rates ranging from 30% in the Seventies to negative values in recent years.

      Are we having fun yet?

      1. RabidGandhi

        Inflation is the very definition of financial instability.

        This may be confusing for some who don’t understand the technical language Comrade Haygood is using. Here are some textual examples of the definition:

        “The Shah is an island of stability in an otherwise turbulent region”

        “Mubarak has brought Egypt years of stability

        “The Pinochet regime has brought Chile stability

        “World Leaders Praise Stability Suharto Gave Indonesia”

        Within this context you will realise that being constantly unemployed is a type of economic stability.

        1. Jim Haygood

          Conclusion: economic stability is a necessary but not sufficient condition for political stability.

          Corollary: extreme levels of inflation or deflation are a strong predictor of a regime being toppled.

          Case in point: the Maduro regime in Venezuela (which doesn’t even publish inflation stats anymore, but it’s thought to be several hundred percent).

          Clearly petitioners have enough support to trigger a recall election. But Maduro is foot-dragging with procedural hurdles. One way or another, Venezuela is going to shake off its self-imposed misery.

          1. RabidGandhi

            So which would you rather have then: an economy with 40% inflation, full employment and 45% COLA increases, or one with 20% unemployment and 0 inflation? Which would be more susceptible to “regime change”? From which sectors?

            And btw, congratulations are due to Mrs RG who had 4 on the O/U for how many posts it would take you to mention Venezuela.

            1. Jim Haygood

              The Phillips curve is the missing link that’s supposed to make the choices you offer feasible.

              But as my Uncle Miltie used to say, the Phillips curve only works in the short term, not in the long term.

              After half a century of chronic inflation, there is no amount of added inflation which could boost Venezuela back to full employment.

              Weimar-style hyperinflation usually burns out in a year or two. Soon Venezuela will be back in competent hands, rebuilding from the wreckage. Then we’ll have to revert to flogging poor old Zimbabwe, which looks ready for another bout by then.

              Saludos cordiales to Ms RG. Tell her this estancia is a great place to spend an anniversary or holiday. The owner Henri used to manage Renault’s plant in Córdoba some decades ago … but “went native” and failed to reintegrate to life in France.


              1. Yves Smith Post author

                Argentina is not in “hyperinflation” much the less “Weimar’style”. Brazil actually handled rates of 20% inflation pretty well because it developed very good inflation accounting, so businesses could figure out where they stood and still had underlying growth that was solid (this in the 1970s-1980s, I know American managers who worked in Brazil then). Argentina’s current level of ~30% is nasty but is hyperinflation.

              2. Skippy

                Too bad about that FX cross hung around their neck, by the usual suspects, and the mates club back at base making free money from it….

                Disheveled Marsupial…. now if they did not have to chew their foot off to slip the trap and chain…. they might walk with out a persistent limp and bloody trail afterwards….

              3. RabidGandhi

                My point wasn’t so much about the Philips curve as it was to get you to acknowledge that inflation is one indicator among many, and it needs to be taken into account in conjunct with others (especially COLA). Here in Argentina, every government has tried to bring inflation down, but the question is whether it is to be prioritised over other stats.

                “Adding inflation” as you say is never a policy goal. Policies are things like having the government create jobs, increase net household worth, invest in infrastructure… and those policies may be inflationary. Rising inflation may increase discontent with the regime, but if both inflation and real median household worth go up, who will be upset with the government? Answer: rentiers.

                Your regards have been duly transmitted to Mrs RG. We, ironically, just passed within a few km of that estate you mentioned (heading home from Córdoba on Route 9), had we known we might have tried to stop in for a peek!

  5. RabidGandhi

    While I agree with Epstein’s overall premise that inflation hawks are a bunch of flat-earthers who should be expelled from the temple, this interview is sloppy and filled with strawmen.

    To begin with, Epstein confuses having an inflation target with having an inflation limit– an easy mistake I suppose since Draghi and Yellen themselves have effectively turned their 2% targets into absolute drop-dead limits that they dare not even think about approaching– but there is no excuse for Epstein to buy into this game. To wit, if 2% were actually a target and not a limit, with inflation at or near 0, shouldn’t the CBs be taking efforts to come closer to the target with the same urgency as they would if it were +4%? But no, we see the opposite; the Fed raised rates on the mere danger that inflation might get closer to the “target”. Thus Epstein’s beef should be with the limit, not the target. Furthermore, I see no problem with inflation targets if they were actually targets and not limits as in practise. Let’s say the ECB actually did have a 2% inflation target: then they would be implementing the expansive monetary policy Epstein is advocating.

    Secondly, by attacking inflation targets and labeling them neoliberal, Epstein has set up various strawmen. His gripe is with inflation hawks… so why does he attack inflation targets instead, which could ostensibly be used for monetary expansion? And to stuff his strawman further, Epstein then links inflation targets with neo-liberalism, trying to somehow show that having targets is less government intervention. Shouldn’t the opposite be true? Bear in mind it was no less than (arch-libertarian!) Alan Greenspan who threw caution to the wind and let unemployment drop below 5% because of an inflation target.

    Lastly, this whole conversation makes Epstein out to be a monetarist in Keynesian clothing. The EU, US and Japan have already pushed every string in their arsenal and then some, so what is he arguing for? More QE? Mega-NIRP? The major absence in his point is he makes no mention of expanding fiscal policy, which as noted here, is the only effective way to get back to full employment. But by focusing solely on monetary policy Epstein instead echoes Friedman.

    I feel Epstein is making a valuable point when he attacks inflation hawks and argues in favour of prioritising employment instead. But by misunderstanding the terms and strawmanning, he does more detriment than good.

  6. JEHR

    So is it that the CB has inflation targets (limits) that result in stagnant wages and salaries? And low interest rates cap what savers (who don’t use Mr. Stock Market) can accumulate? These are both stacked for the benefit of the 1%? It is a cruel world we live in where the elites do what they want and the rest of us suffer and pay.

  7. Jim Haygood

    Legendary hedge fund honcho Stan Druckenmiller concludes his presentation to the Ira Sohn conference last week:

    On a final note, what was the one asset you did not want to own when I started Duquesne in 1981?

    Hint … it has traded for 5,000 years and for the first time has a positive carry in many parts of the globe as bankers are now experimenting with the absurd notion of negative interest rates.

    Some regard it as a metal. We regard it as a currency, and it remains our largest currency allocation.

    Central banksters and legislators can make cash difficult and dangerous to hold, or destroy its value with mandatory exchanges for new notes. But there’s tons of gold out there that have to be held by someone.

    Negative interest rates imply positive carry on gold. Gold l-u-v-v-v-v-s negative rates.

    “They taste like bacon!” barked the old yellow dog.

    1. Detroit Dan

      Gold is not currency and will never be again. Only a fool would think otherwise.

      If gold has value for industrial or ornamental applications, that’s fine. Use it for those purposes like anything else But there are better ways of protecting against counterfeiting these days.

      But go ahead and have your love affair with gold. That will leave more real money (e.g. U.S. government bonds) for the rest of us.

      1. Jim Haygood

        So Stan Druckenmiller’s a fool.

        But he’s a rich fool, so he don’t really care. :-)

      2. animalogic

        Gold may be or may not be a “currency”. As long as many people believe and act like it is a store of value–it WILL BE a store of value (capable of functioning as a medium of exchange.)
        Gold, of course, has some useful intrinsic and contextual advantages: unless acted on by extreme heat, it NEVER alters state, and it is still, relatively, rare…oh, and it does make nice ornaments etc

        1. Yves Smith Post author

          Gold has been as volatile as the stock market post crisis. It went from a low of ~ $660 per oz to a high of over $1900 an oz. It cannot be considered a store of value with volatility like that.

  8. Sound of the Suburbs

    The Central banks target an inflation measure that does not include housing, where all the inflation is.

    The UK moved from RPI to CPI to keep low inflation figures during a housing boom.

    No one needs housing after all!

    A global youth now sit at home with their parents unable to afford the rent or mortgage payments on a place of their own.

    The economists confuse themselves by comparing wage inflation to an inflation measure that does not include housing that everyone needs.

    “I can’t understand why global aggregate demand is suffering” the lack of understanding resulting from fake inflation figures.

    1. Sound of the Suburbs

      In the UK we keep RPI for student loan repayment.

      The BoE can look competent with CPI and students can be fleeced with RPI.

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