I’ve been saying for some time now that it may no longer make sense for DM central banks to obsess over inflation targets.
It became readily apparent years ago that the crisis had probably done irreparable harm to the global economy. Between that and deflationary innovations (think: the increasing role of technology in driving efficiency gains), there’s no hope of recreating the pre-crisis economy.
Given that, it stands to reason that all you’re doing by keeping your foot on the accommodative policy accelerator is inflating asset bubbles.
The problem is that central banks don’t seem to be ready (or willing) to come to terms with the fact that their models may no longer matter.
If that’s true, they’re chasing the dragon. That is, they’re pumping more and more heroin into the system in search of an inflationary high that may not be attainable.
The longer they do that, the bigger the bubbles they’re blowing will get.
Well, on Monday morning, former FX trader Mark Cudmore is out saying pretty much the same thing although, in keeping with his tendency to lean permabull, his concern doesn’t seem to be asset bubbles as much as it is giving policymakers an “out.”
Either way, Cudmore is correct to note that if and when someone finally does throw in the towel on inflation targeting, the FX market ramifications are likely to be profound.
A 2% inflation target is redundant. FX markets will be massively affected by the first major central bank to acknowledge such a fact.
- Does anyone really believe such a target makes sense today? It was always an arbitrary level, and while it may have been appropriate in the early 2000s, it seems to be causing more harm than good now
- There have been concrete examples in recent years — Romania, Poland, Israel, etc — showing that countries can actually outperform economically during sustained bouts of deflation. So inflation isn’t always a prerequisite for growth
- Central banks risk losing credibility if they retain targets that they’ve little hope of reaching. Even more so when the goal doesn’t even seem worth achieving. The BOJ is the prime example of that
- There are structural disinflationary forces in the world due to both technology and demographics. They aren’t going away. Inflation targets either need to be revised, abandoned entirely, or just de-emphasized
- Central bank officials globally have been hinting that the monetary policy framework needs to be revised, but an actual change will be a very difficult communication task. Market participants have been indoctrinated to the idea that inflation is required for economic success. Any hint that targets are being abandoned or lowered would send a negative shockwave
- This topic is relevant for the Fed, the ECB and the BOJ. Since the dollar, euro and yen are three of the world’s most-traded currencies, any related monetary policy shifts will impact all currencies globally
- The Fed may be the last of the three to formally abandon its 2% target. The ECB already has it more as a cap to get close to, but not surpass. And the concept is least relevant to the BOJ because it has failed for so long. Another dollar negative?