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The Inflation Target Trap

Central banks have a problem: economic growth is accelerating, but inflation has failed to take off. But perhaps the solution is not to continue trying to raise inflation – for most people, growth without inflation is ideal – but rather for central banks to end their preoccupation with inflation targeting.

BRUSSELS – Central banks have a problem: growth in much of the world is accelerating, but inflation has failed to take off. Of course, for most people, growth without inflation is the ideal combination. But central banks have set the goal of achieving an inflation rate of “below, but close to 2%,” as the European Central Bank puts it. And, at this point, it is hard to see how that can be achieved.

Central banks never pretended that they could steer inflation directly. But they thought that by providing rock-bottom interest rates and generous liquidity conditions in the wake of the 2008 global financial crisis, they could push investment and consumption upward. In 2009, when financial markets were in turmoil and the economy was in free-fall, the US Federal Reserve took matters a step further, initiating large-scale asset purchases, or quantitative easing (QE). The ECB followed suit in 2014-2015, when deflation appeared (wrongly, in hindsight) to threaten the eurozone.

The Fed’s actions certainly helped to stabilize financial markets. The ECB also claims that its bond purchases, after financial markets had already normalized, sparked economic growth and fostered employment. But the impact ended there.

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