Some of the world’s top central bankers are putting inflation-fighting efforts on ice as they struggle to keep the global recovery alive.
Haunted by the downturn of 2008 and Japan’s lost decades, policy makers in the United States, the United Kingdom, the European Union and elsewhere have decided to tolerate higher prices until their economies are secure.
Bank of Canada governor Mark Carney this week reinforced that he is a member of that group, indicating he will ignore hotter-than-expected price gains, such as the August numbers reported on Wednesday by Statistics Canada, for the foreseeable future.
Three summers ago, when oil prices were soaring to $150 (U.S.) a barrel, the European Central Bank’s aggressiveness in trying to tame inflation hastened the region’s slide into recession. This time, no one – including ECB President Jean-Claude Trichet – wants to make the same mistake. Plus, Japan’s battles with deflation for the better part of two decades show it can be harder to stop a downward spiral in prices than to tame inflation.
“Premature tightening would have quite a bit more cost than … benefit,” said Robert Kavcic, an economist with BMO Capital Markets in Toronto. “As we’ve seen from historical cases, like Japan, once that deflation mentality sets in, it becomes self-fulfilling and it becomes very hard to get out of.”
U.S. Federal Reserve Board chairman Ben Bernanke, and Mervyn King, governor of the Bank of England, have also left rates unchanged in the face of rising inflationary pressures.
Some officials at the Fed have suggested that until unemployment is lower, U.S. interest rates should stay at rock-bottom levels long enough for inflation to hit 3 per cent.
Mr. King, meanwhile, has held his benchmark at a record low – even though inflation in the U.K. has been above the Bank of England’s 2-per-cent target for 21 months – and is considering pouring more cash into the financial system to keep the recovery from faltering, as the Fed did on Wednesday.
Canada’s consumer price index rose 3.1 per cent last month from a year earlier, accelerating from the previous month’s pace and breaching the top end of Mr. Carney’s target range. Plus, Statscan’s index of core inflation, which strips out volatile items such as gasoline and fresh foods, quickened unexpectedly to a 1.9-per-cent annual pace, the fastest since April, 2010.
But in a speech Tuesday to a business audience in Saint John, N.B., Mr. Carney stressed that since risks to the economy are “skewed to the downside,” he reserves the right to take longer than the typical two years to return inflation to his target.
“Our decisions are guided by considered analysis and informed judgment rather than mechanical rules,” Mr. Carney said in his speech. “Both the size and nature of the shocks that hit our economy can have a bearing on the appropriate targeting horizon.”
In other words, his benchmark interest rate will stay at the current 1 per cent until the economy can handle higher borrowing costs, even if that means inflation is higher than he’d like for a while.
“It’s not that he’s ignoring his target, he’s just reminding people it’s 2 per cent for a longer-term horizon,” said Krishen Rangasamy, senior economist at National Bank Financial Inc. in Montreal, adding a knee-jerk reaction by more central banks in 2008 would have triggered a global depression. “That’s why central bankers look past temporary factors influencing inflation and ask whether inflation can go back to their target over a longer horizon.”
The decision to emphasize growth over temporary spikes in the cost of living is not as obvious as it seems. Many central banks remember what it took to choke double-digit inflation in the 1970s and one, the ECB, is heavily influenced by Germany’s intense aversion to inflation.
In July, when energy and food costs were pushing up wages in Germany while many other euro-zone nations were drowning in unaffordable debt, Mr. Trichet raised rates, a move many say exacerbated the region’s crisis. In recent weeks, he has signalled the ECB may reverse that move, as austerity measures crimp growth, and confidence in European banks erodes.
Even now, tolerating higher inflation to kick-start economic activity can be a tough sell.
On Wednesday, Mr. Bernanke’s Fed said it will buy $400-billion (U.S.) of Treasury securities with remaining maturities of six years to 30 years, a program it will fund by selling its holdings of assets with maturities of less than three years. The idea, of course, is to keep long-term interest rates low enough to prevent another economic slump.
Almost as soon as the plan was announced, many economists questioned whether it would have much impact. A bolder move, however, like creating more new money to purchase assets, would have attracted the same criticism as last year’s “quantitative easing” program – which many economists, including some on the Fed’s policy team, warned could ignite inflation.