Time is ripe for change in monetary policy style

In spite of large doses of policy easing, inflation and global growth remain tepid. With the effectiveness of existing monetary policy styles therefore being increasingly questioned, the November 2016 issue of Perspectives looks at three of the most plausible alternatives.

One is asset-price targeting. Could central banks assume responsibility for ensuring the stability of asset prices as well as price stability? Christophe Donay, head asset of asset allocation and macro research thinks this style raises too many questions and therefore “is not quite ready” to become the next monetary policy ‘style’. An alternative calls for central banks to target nominal GDP. This style would involve central banks running pro-active policies to maximize GDP growth, while at the same time keeping volatility as low as possible.  Flexible inflation targeting, a third alternative policy ‘style’, seems to be gaining headway in central bank circles. Indeed, with the IMF drawing attention to its potential to tackle low growth, flexible inflation targeting “stands the best chance of becoming the template for future monetary policy”, according to Donay, in spite of the risk of disrupting natural market mechanisms.

More generally, there is a need for monetary policy to work in tandem with budget policy to be fully effective. Alas, says Donay, “politicians [are] not entirely prepared to push through appropriate fiscal measures to underpin growth.” Indeed, alongside growing disappointment with monetary policy, Donay argues in his editorial that “budgetary policy has turned out to be a damp squib in terms of supporting sustainable growth and spending since 2008.” Proof of this, he writes, “is the tendency for growth to slow each time governments try to rein in public spending”. Once the world had been saved from the depression that the financial crisis threatened , “more appropriate fiscal policies should have been introduced to revive productive investment and capacity,” argues Donay.