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The Wrong War for Central Banking

Fixated on inflation targeting in a world without inflation, central banks have lost their way. With benchmark interest rates stuck at the dreaded zero bound, monetary policy has been transformed from an agent of price stability into an engine of financial instability.

BEIJING – Fixated on inflation targeting in a world without inflation, central banks have lost their way. With benchmark interest rates stuck at the dreaded zero bound, monetary policy has been transformed from an agent of price stability into an engine of financial instability. A new approach is desperately needed.

The US Federal Reserve exemplifies this policy dilemma. After the Federal Open Market Committee decided in September to defer yet again the start of its long-awaited normalization of monetary policy, its inflation doves are openly campaigning for another delay.

For the inflation-targeting purists, the argument seems impeccable. The headline consumer-price index (CPI) is near zero, and “core” or underlying inflation – the Fed’s favorite indicator – remains significantly below the seemingly sacrosanct 2% target. With a long-anemic recovery looking shaky again, the doves contend that there is no reason to rush ahead with interest-rate hikes.

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