Inflation Targeting and Neoliberalism, Part 2

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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. 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.Originally published at Triple Crisis

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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  1. beene

    What is needed is a Federal public bank, before the debt based private Federal Reserve bank of NY bankrupts the nation with debt. Soon the interest on national debt will consume all the income of the Nation. It now takes almost a third of the Nations income each year and growing.

    The url below is an example of the difference in public and private created debt (money).

    1. Yves Smith Post author


      No, the Federal government can always create more currency to pay interest. It does not come of of national income. The government creates money out of nothing.

  2. craazyboy

    I guess economists will never figure it out until they get their Keynesian hats out of the closet, dust ’em off and put them on. There is no way to do “inflation targeting” right in a vacuum.

    This should be obvious to anyone after 8 years of QE and ZIRP leading to at least a quadrupling of the money supply in a world economy of income inequality, decades of growth fueled by increasing debt at personal, business, and government levels, stagnant income growth for the 99%, tax cuts or tax avoidance for the 1% and large corporations, and the only effect of cheap and copious supply of money is asset inflation, corporate stock buybacks and mergers.

    Looks like the only people that can’t figure out what’s wrong with this picture are economists and the 1%.

    1. Synoia

      Looks like the only people that can’t figure out what’s wrong with this picture are economists and the 1%.

      Feature, not bug.

  3. John Wright

    One positive characteristic of inflation is that it allows paying off debt with cheaper money.

    With many Americans with low net worth, high mortgage debt, home equity loans, student loans, credit card debt and car loans, one finds it difficult to believe these indebted USA citizens have a desire to keep inflation low.

    Some of these consumer loans are likely at a fixed interest rate, not indexed to inflation.

    And Social Security is indexed for inflation, so the elderly poor are somewhat hedged for inflation..

    So it would seem that much of the working population in the USA would want to encourage much more inflation, fully expecting it would result in a nominal wage rate increase allowing them to pay/service their accumulated debt much more easily.

    1. inode_buddha

      If inflation and wages had anything to do with each other, you wouldn’t need union membership just to get a living wage, let alone anything above that. This is regardless of merit or education level — that has very little to do with it too.

    2. Alejandro

      I’m sure what you posit makes sense and seems bubblelicious in some circles, but from my POV, “trickle-down” was, and apparently continues to be a scam. While correlation is not necessarily causation, you may have noticed income AND wealth inequality does not support your opinion.

      “indexed to/for inflation”, “hedged for inflation”…”trust fund”( one of the debates)…

      Have noticed a recent effort to intensify the use of the language of wall street with Social Security…wall street and Social Security seem antithetical to each other…when “markets” decree “go die!”, Social Security has responded with “not yet!”…

      1. OpenThePodBayDoorsHAL

        Sometimes the simplest explanations are the best ones.
        Stop someone in the street and show them an apple. Ask them if they would rather pay $2.00 for the apple, or $1.00.
        The idea that higher prices are somehow always good is silly. “Oh but people will forego consumption and await lower prices”. OK. Tell me exactly how I am supposed to forego expenditures for rent, and food, and gasoline, and utilities, and medical care? Yes I might forego the purchase of a washing machine…but goods like that represent about 10% of my outlays.
        “But inflation is good for debt holders”. But I thought our problem was too much debt? If those debts are unserviceable then the sooner they are written off the better, starving savers of income with ZIRP and NIRP and removing all consequences for bad underwriting just exacerbates on the other end.
        The truth is we have a deluded priesthood of neo-Keynsians, ideologues of the worst kind because they are wrong. They are hammers wandering around looking for nails, when they can’t find any they just beat on you and me.

        1. Banana Breakfast

          You’re talking about and conflating multiple different kinds of inflation, or inflation of different things, which “inflation targeting” tends to do as well. Price and wage inflation are, obviously not directly and immediately connected, but it’s become very clear that asset price inflation and especially real estate price inflation are not strongly connected to monetary inflation either.

          Notably I don’t have a clue what your’e talking about with the “problem was too much debt” stuff. Monetary inflation will make debts that aren’t inflation adjusted easier to pay off by making the money to pay them more available, i.e. their real value will decrease. This has nothing to do with bad underwriting or whatever – though in some cases it does mean instead of taking a haircut on the full amount of a loan when someone is forced to default or go bankrupt, they’ll take a partial loss by getting paid back in money of lower real value than the original loan + interest, whether the initial underwriting was “good” OR “bad”.

          I totally fail to see any neo-Keynesians in positions of monetary authority in the US or Europe at the moment so that whole last bit just seems absurd.

        2. TomD

          Inflation shrinks debt in real terms. So yeah, a possible solution to too much debt is inflation.

          “savers” are such a small percentage of Americans, I’m not sure economics should cater to them at all.

    3. lyman alpha blob

      To paraphrase William Jennings Bryan – “You shall not crucify mankind on a cross of groaf !”

  4. JEHR

    So central banks and financiers treat inflation as though it must be controlled by keeping it low. If wages and salaries were to increase due to inflation, then the elites (especially employers who hire workers) would think that is not a good thing. Perhaps a world that suffers from deflation is what the 1% really like. It looks as if control of monetary policy (by creating lots of money) and fiscal policy (by eliminating public debt) creates the perfect world for elites who get richer and richer while the rest get poorer and poorer. We seem to be in a cycle that will be hard to break out of.

  5. Jim Haygood

    ‘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.’

    No economy, anywhere, that’s running 15% to 20% inflation has a well-functioning bond market to fund governmental and private investment.

    Such countries borrow overseas, in euros or dollars or yen, since they’ve sh*t their own nest with gratuitous inflation.

    Double-digit inflation is greasy kid stuff, as the Vitalis ads used to warn. It’s a prima facie indicator of a mismanaged economy.

    People hate double-digit inflation. The presidents who presided over the twin peaks of U.S. inflation in 1974 and 1980 both got ejected from office. The sum of inflation and unemployment is called the “misery index” for a reason.

    1. Synoia

      Such countries borrow overseas, in euros or dollars or yen, since they’ve sh*t their own nest with gratuitous inflation.

      Which is a mistake. Import substitution, combined with capital controls and balanced trade. Which is want we had in the ’70s.

      Hurt by the oil shock, and blown away by Bill Clinton.

    2. TomD

      Woodrow Wilson got re-elected with 18% and 17% inflation in ’17 and ’18, and Truman got re-elected with 3 years of 8%, 14% and 8% inflation.

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