The Bank of Japan has been trying to juice its economy for more than a decade. The U.S. Federal Reserve, the European Central Bank and Bank of England have been at it for more than four years. The efforts – near-zero policy interest rates and bond-buying with newly created money – have not produced much. In 2013, the siren call of inflation will become more alluring.
For today's central bankers, inflation used to be enemy No. 1. Most of them came of age during last century's clashes with consumer prices. In Japan and Germany, the collective memory of hyperinflation still haunts interest-rate gatekeepers. It is hard to abandon the battle, even if it has been won definitively and is no longer relevant.
Ben Bernanke, Mario Draghi work with targets that look right – for a pre-recession world. The Fed and the EBC aim at just 2 per cent in any year – a rate established through faith more than science in the 1990s. The Bank of Japan has painted its bull's eye at just 1 per cent.
Times have changed. After the credit bubble, the world is left with a mountain of debt and no easy way to erode it. A higher rate of inflation would not make the mountain shrink, but it would make it less dangerous, since there would be more GDP available for debt service.
Many economists have been dropping hints that a new, higher inflation target rate would not be a bad idea. The thought, common in the 1970s, that a 5-per-cent rate was acceptable, is still too radical, but Olivier Blanchard of the International Monetary Fund did suggest 4 per cent in a 2010 paper. And the Fed changed its policy in December to say it would be comfortable with 2.5 per cent inflation when the unemployment rate is high.
It may take some work to make investors comfortable with higher targets, and a different sort of work actually to push up prices. And the traditional objection to inflation – that it unjustly punishes the prudent and the weak while rewarding the reckless – still holds. But there may be no better alternative.