The future of central bank frameworks

Inflation targeting has come of age. From this week’s Barclays Equity Gilt Study:

Monetary-policy regimes have changed over time. Inflation targeting (IT), which was ‘born’ in 1990, will soon have reached a lifespan associated with other historical monetary-policy regimes: the Gold Standard (1870s-1914) and the Bretton Woods system (1948-1973), as well as the periods between wars (1919-1939) and between Bretton Woods and IT (1973- 1990s), when no single policy framework dominated.

Just as past data are not always a good guide to future performance, so the lifespan of past globally dominant monetary regimes is not always a good guide to when the current arrangement will give way.

But the Barclays analysts also point out that central banks have “evolved since the Global Financial Crisis, and what were initially deemed extraordinary measures are now part of the standard policy toolkit”.

It is inevitable that any approach eventually becomes untethered from the historical context which gave rise to it — especially, in the case of inflation, when you factor in underlying demographic and societal changes. The problem of too much inflation has turned into a problem of too little inflation, or the wrong kinds of inflation.

The discussion is now moving towards alternative targets, including average inflation, or even GDP, which Barclays documents in depth. This week, Labour said that they are considering targeting house-price inflation (though it is unclear whether this amounts simply to regulatory constraints on mortgage lending, which have already been implemented over recent years in the UK).

Elsewhere, movements have emerged that propose environmental targets for central banks, usually in relation to the collateral framework — a push to “green the financial system”. And in the US, Stephen Moore, Trump’s nominee for the Federal Reserve, has suggested targeting commodity prices.

One interpretation of these new proposals is as a kind of technocratic political gambit. Central banks offer a way of proposing policy solutions for widely discussed problems that do not involve tax. The current framework for debate, after several decades of central bank independence and low inflation, is more sensitive to the perceived distributional consequences of taxation than inflation (there are many examples historically when the reverse has been true). See: France.

As Barclays points out, central banks have already pursued highly unconventional approaches since the crisis, though they still mostly related to inflation. Another shift is that the new proposals are overtly related to universally discussed problems (climate change, the cost of housing) rather than issues like the stability of secondary markets for sovereign debt, or the funding requirements of peripheral banking sectors. It wasn't necessarily that the ECB’s corporate bond purchases weren’t radical; it was that a very small number of people talked about them.

As Barclays puts it:

The future of monetary policy frameworks has entered the discussion in other central banks as well, even if merely for debate. In academia, more radical concepts are being discussed, many of which seek a break from longstanding policy and social conventions. They may be far from being seriously considered today, but if the past decade has shown anything, it is how quickly the unorthodox can become orthodoxy.