BoC’s Carney Questions Wisdom of Rigid Inflation Targets
In remarks published today, BoC Governor Mark Carney suggested that more flexibility in monetary policy should be considered in light of the shocks current markets have experienced.
Speaking at the annual conference of the Bank for International Settlements in Switzerland, Carney appeared to muse over policy direction:
* Policy frameworks should be flexible enough to allow the natural adjustment processes in the economy to determine the speed of adjustment to shocks
* Fixed exchange rates or subsidized energy prices make adjustment to economic shocks more costly; such rigidities impose costs on other countries because flexible prices must adjust in an unnecessarily large or rapid way
* In the face of major market shocks, monetary policy depends on both its ability to be flexible and credible
* In principle, monetary policy is built around the notion that it is best for policy to let inflation return to target at different speeds, depending on the type and characteristics of the shocks hitting the economy. In practice that doesn’t happen — the inflation target can’t take the type of shock hitting the markets into account but is forced to respond the same way for every scenario. That adds credibility and stability, but is there another way?
Carney mused that in the increasingly globalized economy, central banks might be better able to adjust to market shocks if they didn’t have to follow rigid inflation targets (as does the BoC), provided that policy is clear and transparent enough to maintain credibility. He suggested that central banks might be better served if they temporarily tolerated inflation outside their target ranges or allowed a more flexible time horizon for bringing inflation to heel.
The BoC has an inflation target set within a range of 1-3% and adjusts interest rates to bring the rate to 2% within a period of 18 to 24 months. Carney pointed out that his remarks had no immediate bearing on the BoC, which is committed to its current target until the end of 2011.