Friday, February 12, 2010

Round and Round...

They still don't seem to understand, and are commingling the issues of interest rates levels, and the granular credit decisions that create liquidity and inflation.

If the interest rate channel is "broken", altering the level of rates will not necessarily create credit demand as that is a function of both the cost of capital and the return on capital. If there are no opportunities, bank lending declines. This is exacerbated when bank capital is already under pressure from decreasing asset prices.

And, by the evidence we have regarding bank credit, this is precisely what is happening.

IMF floats plan to raise inflation targets

By Chris Giles in London

Published: February 12 2010 00:06 | Last updated: February 12 2010 00:06

International Monetary Fund economists are challenging economic orthodoxy on Friday by suggesting that many pre-crisis policy tools should be redesigned and some sacred cows considered for slaughter.

A staff paper co-authored by Olivier Blanchard, IMF chief economist, says the financial and economic crisis has “exposed flaws in the pre-crisis policy framework” and “forces us to think about the architecture of post-crisis macroeconomic policy”.

Suggestions include raising inflation targets from about 2 per cent to about 4 per cent so that monetary policy can better respond to shocks; automatic lump-sum payments for poorer families if unemployment rises above certain thresholds; exchange-rate intervention for smaller economies that depend heavily on trade; and giving central banks huge new regulatory tools so they can smooth the path of the economy.

The political momentum behind many of the ideas is absent, Mr Blanchard accepted. The IMF is taking a gamble by spelling out the flaws in current thinking, even if it is in a staff paper rather than formal recommendations.

Some of the tools suggested have been used in the crisis, but boosting the Federal Reserve’s powers, for instance, is highly controversial in the US.

The suggestion that inflation targets should be raised to 4 per cent will cause many central bankers to choke on their breakfasts, since they have spent their whole careers gaining and preserving the credibility of keeping inflation at levels close to 2 per cent.

‘If we had had more margin to play with on interest rates, we would probably have had to use fiscal policy less [in the crisis]‘
Olivier Blanchard, IMF chief economist

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