Home > Uncategorized > Inflation targeting? Or credit targeting?

Inflation targeting? Or credit targeting?

What should central banks do? Do they have to control inflation by targeting the amount of money? Should they ‘lean against the wind’ when it comes to bubbles? Or is ‘inflation targeting’ the silver bullet of central bank policies? A case can be made that central banks should ‘lean against the wind’ when it comes to credit: they should discourage ‘unproductive’ lending (i.e. lending to buy assets, including existing houses), though ‘macro prudential’ tax policies might be a better tool to do this and. And, surely in case of a severe crisis, they should encourage productive lending by banks to households, companies and yes, also the government. Any way, ‘credit to the private sector’ seems to be a much better indicator of the state of the business cycle than the supply of money or inflation. The dot.com bubble and the housing bubble were not characterized by high consumer price inflatin (the target variable of the ECB) or, in the case of the dot com bubble, by high money growth. They were both characterized by high credit growth (the difference between M-3 money and credit to the private sector is, at the moment, especially caused by lending to non-Eurozone companies). Oh, and this is the time to be resolute and credible, when it comes to this, as Kocherlakota understands. Via @cigolo.

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  1. November 28, 2013 at 8:35 pm

    If you believe that a central bank can by monetary policy directly affect and therefore target inflation, then you are assuming that money is NEUTRAL in either the short run and/or the long run.

    Keynes wrote in as 1935b article that he was developing a theory applicable to the real world where money was not neutral in either the short run or the long run.

    Accordingly in Keynes-Post Keynesian theory money is never neutral and the central bank can not affect the rate of inflation of producible goods and services except by making the demand for such things either so strong or so weak, that y producers and workers) of these things gain (or lose) sufficient market power to exercise an increase ( or accept a decrease) in their ability to alter market prices. Thus, as Keynes pointed out in the Treatise on Money one major form of inflation (or deflation) was incomes inflation (or deflation). The obvious solution for incomes inflation is an incomes policy.

    • merijnknibbe
      November 28, 2013 at 11:21 pm

      For the record: I do not believe that central banks can directly affect inflation in any way. They even have a hard time to targeting household and company interest rates and the idea that a central banker can influence inflation expectations just by stating a target and via that channel inflation is, to me, a classic example of hubris.

  2. November 28, 2013 at 8:52 pm

    The hard part, of course, is distinguishing “productive” versus “unproductive” lending. But I think I have an answer to this:

    (a) Begin requiring intensive training in ecological economics for all new hires into personal and commercial lending positions at private sector lending institutions, and for all new hires at central banks
    (b) Develop better metrics of the external “ecological and social opportunity costs” of a wide range of goods and services (the incremental research could be funded by a temporary tax on bank profits, or by a broad-based carbon tax)
    (c) Require the use of the metrics developed under (c) in credit application scoring
    (b) Require external audits of institutional lending by independent firms of ecological economists (who should in turn, be audited by firms of ecological economists who do not themselves offer auditing services to lending institutions)

    A great deal of unproductive lending would be eliminated if investments that tended to deplete collectively owned natural capital, or social “trust capital” (that is, investments that struggle to procure even a modicum of social licence) had to struggle a lot harder in the credit-scoring process.

    Michael Barkusky
    Pacific Institute for Ecological Economics
    Vancouver BC

  3. Lyonwiss
    November 29, 2013 at 1:01 am

    “What should central banks do?” Nothing, is my answer. Central banks have already caused great harm to the economy with meddling which has created a never-ending sequence of crises.

    From the link, Kocherlakota reportedly fired Patrick Kehoe (PK) who dared questioned any evidence for the efficacy of intervention in the financial crisis. In one of his papers (“Facts and Myths about the Financial Crisis of 2008”) he wrote:

    “Moreover, we argue that even if current increase in spreads indicate increases in the riskiness of the underlying projects, by itself, this increase does not necessarily indicate the need for massive government intervention. We call for policymakers to articulate the precise nature of the market failure they see, to present hard evidence that differentiates their view of the data from other views which would not require such intervention, and to share with the public the logic and evidence that burnishes the case that the particular intervention they are advocating will fix this market failure.”

    Unfortunately for PK, he did not understand how government research works and he paid the price apparently for the ignorance. Government research has the main function of supporting and confirming, with theoretical and empirical evidence, existing government policies, and not to formulate them.

    The government shoots its messengers who deliver unfavorable ideas or findings to predetermined policies. This is the reason why hundreds of highly paid and well-resourced economists working in various US government agencies make no real impact on economics or public policy. This is also the reason why government bureaucracies are wasteful and structured to fail.

    • Merijn Knibbe
      November 29, 2013 at 10:07 am

      A) Doing ‘nothing’ is, in the case of central banks, also doing something… as they do have an important ‘normal’ role in guaranteeing liquidity to banks and the like. They are in one of the driver seats and not steering when the road bends is an act, too. However, central banks have been spectacularly bad when it came to understanding the 2005-2007 boom (the Dutch National Bank did issue increasingly shrill warnings, the ECB however saw nothing, nothing coming, among other things because they were misguided by Robert Lucas style ‘inflatin targeting’ economics which ruled out the very possibility of a 2008 style crisis as long as consumer price inflatin was low and stable. So, I do understand your point but ‘doing nothing’ is not an option. And I do think that Bernanke was the man of the match, in the fall of 2008.

      B) What I like about Kotcherlakota: he understands that his ideas implicate that, to be ‘credible’ in the neoclassical sense, a central bank not only has to create a worldwide recessions to get inflation down (as Volcker did back in 1981) but has to be as bold as it comes to fighting deflation.

      C) However – I don’t agree with his ideas and think that this worldwide recession in 1981/1982 was a huge, massive policy mistake, that ‘inflation targeting’ is bonkers (they don’t even look at a credible metric as they target consumer price inflation instead of domestic demand inflation) while the influence of monetary policy on actual spending and investing and even interest rates is limited.

      D) And targeting (or at least focusing on) credit has the advantage that central banks have to emphasize a variable which is more cyclically sensitive and slightly more under their control than inflation. but ‘credit’ should not be defined in a neoclassical framework but (1) in a classical framework which includes ‘land’ (unproduced factors of production, including clean air and clean ground and the like) and assets (products with a zero elasticity of production, in the terminology of Keynes, like existing bitcoins) and (2) in a Post-Keynesian framework which emphasizes that money is a real thing and as such is non-neutral for the very reason that it exists (for one thing we just do not know what our monetary savings will be worth, in the future, nog just because of inflation and the like but also because of the introduction of new products (or the deterioration of the effectivity of existing products, like antibiotics) which means that we by definition can’t decide about the optimal mix between present and future consumption) while the idea of endogenous money (the cornerstone of monetary statistics, by the way) of course re-introduces the possibility of monetary induced cyclical developments. Which is, by the way, also stressed by Austrians.

  4. sergio
    November 29, 2013 at 1:56 pm

    What should central banks do?
    They should not exist.

    November 29, 2013 at 2:23 pm

    It is easy to explain why central banks can not greatly control inflation for several reasons,
    1 The interest rate they control only benefits agents that can borrow directly from the central bank. 0.25% direct mortgages or student loans would definitely get money to the people using it.

    2.There are two types of loans. Central Bank loans that create money and all other loans from any lender that create velocity, MxV = buying power. Even a small increase or decrease in secondary lender velocity = a lot of buying power.
    3. Most inflation is caused by cost of interest, deadweight loss and externality included costs,not too much money.

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