When Central Banks Change Focus

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Byline: Hamish McRae

IS central banking about to make another of its once-in-a-generation shifts in direction, this time away from focusing on inflation? The question arises because three of the world's main central banks are changing their objectives. One has already done so; the European Central Bank, under its Italian president Mario Draghi, has, in effect, shifted its principal aim from keeping inflation under 2% to saving the euro. As he put it, "we will do whatever it takes", which as he then demonstrated included the commitment to buy the sovereign debt of distressed eurozone members.

The second change was announced last week in a speech by Ben Bernanke, chairman of the Federal Reserve Board in the US. He said it was likely that the Fed would keep official rates near zero as long as unemployment remained above 6.5%, inflation was projected to remain below 2.5%, and inflation expectations remained contained.

He did qualify this: "Let me emphasise, that the 6.5% threshold... should not be interpreted as the committee's longer-term objective for unemployment."

But as far as I recall, this is the first time a major central bank anywhere in the world has included an unemployment target as a guide to policy. The third example of a change in objectives has not yet happened but the probability has increased since the Bank of England's new Governor was named. Mark Carney does not arrive until the summer but already his every word is being dissected to see if there might be some guide to future policy. So when, speaking in Toronto last week, he pondered whether central banks might drop inflation targets in favour of a target for nominal GDP, this set things moving. George Osborne gave the story legs when he said he was glad Carney had raised the prospect of switching away from inflation targets towards targets which focused more on growth.

The idea of a money GDP target is not new. It was implicit in the money-supply targeting adopted by the British authorities during the Eighties as away to control inflation, before we switched to an inflation target. Thus, targeting inflation only has a 20-year history and though it has been core to the ECB, the US has never had an explicit target.

In the UK, some sort of revision is clearly necessary for two reasons. First, it did not prevent the Bank of England making the huge policy error of fuelling the most serious property bubble that has ever occurred in the UK. …