PRINCETON – Can central banks contain inflation? We once thought they could. Over the past 20 years, central banks around the world, including the United States Federal Reserve, pursued price stability with remarkable success. But now, in the wake of the financial crisis, a tide of distrust is sweeping the world – including a new and widespread fear that central banks are incapable of controlling inflation.
In the US, the Tea Party has made a return to the gold standard a part of its platform, and Utah is debating making gold and silver coins legal tender. German inflation worries have pushed the government into a much harsher stance on debt relief in Europe. In China, fear of inflation is unleashing large-scale discontent.
Inflation fear was already present before the new challenges of 2011 raised questions about long-term energy prices. As pro-democracy protests shake Arab authoritarian regimes, the prospect of sustained conflict threatens a global economy still dependent on oil, while the aftermath of the Japanese earthquake and nuclear accident raises doubts about the security of nuclear energy.
The main anchor of central banks’ monetary policy over the past 20 years was an inflation-targeting framework that developed from academic interpretation of the problems involved in targeting monetary aggregates. After successful experiments in smaller economies, New Zealand in 1990 and then Canada in 1991, and later in Sweden and the United Kingdom, the conviction developed that the new approach represented a superior way of dealing with the problem of inflationary expectations.