Scepticism about inflation targeting: Edward Chancellor

Inflation targeting has become the norm in many countries, including India. Edward Chancellor, journalist, historian and author, sounds a sceptical note in this article. He has provided a more elaborate critique in a book, The Price of Time.

Chancellor says that inflation targeting has allowed central banks to set ultra-low interest rates in response to bouts of deflation and to justify the same by citing the inflation target given to them. As long as inflation stays below target, the interest rate set by a central bank is okay.

Chancellor thinks that is not okay. There are a number of malign effects of ultra-low rates that must be taken into account:

Yet these targets produced a number of corruptions and distortions. Ultra-low interest rates pushed the US stock market to near record valuations and provided the impetus for the “everything bubble” in a wide variety of assets ranging from cryptocurrencies to vintage cars. Forced to “chase yield”, investors assumed more risk. The fall in long-term rates hurt savings and triggered a massive increase in pension deficits. Easy money kept zombie businesses afloat and swamped Silicon Valley with blind capital. Companies and governments availed themselves of cheap credit to take on more debt.

Central banks must, therefore, be guided not just by the level of inflation but also by its effects of interest rates on asset valuation, financial stability, leverage and investment. In other words, we are back to multiple objectives for central banks instead of a single objective, namely, inflation! 

This may sound plausible. Except that, elsewhere, Chancellor argues that the alternative to ultra-low interest rates is simply to not respond to bouts of depression because they tend to cleanse the economy of unproductive or inefficient firms. That is more than a little extreme. The idea that governments should have stood by when the pandemic erupted is hard to swallow. You must read Martin Wolf's critique of Chancellor's  book to get the complete picture. It is all very well to ask central banks to take asset bubbles into account but we know that that is a notoriously difficult task. When is an increase in asset values a bubble? We do not have a clear answer. 

At the same time, as Wolf points out, it is important to take on board Chancellor's plea to factor financial stability into central bank policy. The interest rate is a useful tool for battling recession. At the same time, central banks must address threats to financial stability through various instruments of regulation. Excessive leverage is an issue both in the financial sector and in the corporate world. Wolf says that removing tax deductibility for debt must be part of the solution. The solution has been urged by many. The time may have come to consider it seriously.