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Analysis

Inflation: a chance for central bankers

Return to traditional arguments will suit policy-makers

by Miroslav Singer in Prague

Tue 24 Jan 2017

The consensus that inflationary pressures are returning to the global economy grows ever stronger. If this becomes manifest, central banks may need to tighten monetary policy and end the use of unconventional tools for easing monetary policy.

Politicians in many economies are unlikely to welcome this tightening. Donald Trump, for one, would not relish the associated strengthening of the dollar, as it would reduce the competitiveness of the US manufacturing sector that he promised to revive. In the euro area, the fragile state of some members’ financial sectors and unfinished euro area institution-building are likely to complicate withdrawing from unconventional policies. As the recovery gains pace, the erosion of labour market slack and the narrowing of the euro area-wide output gap will exacerbate inflationary pressures.

This is all happening in a setting where popular resentment against elites – among whom central bankers are certainly counted – is changing the political make-up of many major economies. Central banks may find themselves attractive targets for political point-scoring.

It is reasonable to expect a host of proposals to allow inflation to rise above targets, and possibly even pressure to increase the targets. The same logic that prevented central banks from lowering targets during the deflationary period, namely their reluctance to loosen mid-term expectations, should prevent central bankers from heeding such advice. Otherwise, they would act procyclically, which would negate the ultimate reason why they are independent.

Still, politicians who have been recently elected, like Trump, and others who are proving popular, such as right-wing figures Marine Le Pen in France and Geert Wilders in the Netherlands, tend toward stridency. Politicians and central bankers face increasingly candid squabbles.

In the short term, expect more orthodox argument among central banks about why it is necessary to keep inflation low. That will be a great improvement over recent times when central banks found themselves explaining why it is necessary to use unorthodox policies like quantitative easing to avoid deflationary threats.

Central banks have shown themselves over many years quite efficient in this type of dialogue. Moreover, in this environment, conventional monetary tools are more efficient. Central banks will rightly welcome a return to more traditional monetary policy. Operating the instruments for these circumstances, and taking part in the associated arguments and discussions, will suit them much better.

Miroslav Singer is Director of Institutional Affairs and Chief Economist at Generali CEE Holdings. He is former Governor of the Czech National Bank and a Member of the OMFIF Advisory Board.

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