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August 13, 2013

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America needs a central banker to fight deflation

By Kenneth Rogoff | August 13, 2013, Tuesday | Print Edition

THE battle is on to replace current US Federal Reserve Chairman Ben Bernanke.

The choice is largely at the discretion of the US president. So let us consider two of the leading candidates, Lawrence Summers, a former US treasury secretary, and current Fed Vice Chair Janet Yellen.

Both Summers and Yellen are brilliant scholars with extensive experience in public service.

Whereas the mainstream press seems intent on exploring their candidacies as a contest of contrasting personalities, the fact is that both candidates are extremely well qualified.

Moreover, both have a reputation for believing that the Fed should not place excessive weight on price stability relative to unemployment. Normally, this dovish bias would be a handicap; nowadays, it is an advantage.

Some are criticizing Summers’ ardent pursuit of financial deregulation during the 1990s, when he headed the US Treasury under President Bill Clinton. But these critics overlook his role in helping to fight that decade’s sovereign-debt crises, and his insistence that the US begin issuing inflation-indexed bonds.

In a complex and ever-changing policy setting, it is almost impossible to get every call right, and the important thing is to learn from one’s mistakes.

Winston Churchill famously regretted overseeing the United Kingdom’s catastrophic return to the gold standard in 1925, when he was Chancellor of the Exchequer.

His performance, needless to say, improved in later years.

Yellen’s speeches on financial risks showed more foresight than those of most of her peers.

Bulwark against pressure

Typically, one looks to the head of the central bank to serve as a bulwark against political pressure to push down interest rates and raise inflation.

My own research in 1985 on inflation and central-bank independence showed that, in normal times, one generally wants a central banker who places greater emphasis on price stability relative to unemployment than an ordinary informed citizen might do.

Installing a “conservative” central banker helps to keep inflation expectations in check, thereby holding down long-term interest rates and mitigating upward pressure on wages and prices.

For the past 25 years, the mantra of “inflation targeting” has served as a mechanism for containing inflation expectations by reassuring the public of the central bank’s intentions.

But excessive emphasis on low inflation targets can be counterproductive in the aftermath of the worst financial crisis in 75 years.

Rather than worrying about inflation, central bankers should focus on reflating the economy. The real problem is that they have done such a good job convincing the public that inflation is the No. 1 evil that it is difficult for them to persuade anyone that they are now serious about reflation. That is why appointing a “dove” would not be a bad thing at all.

Yellen has already developed a reputation as a dove with’s high unemployment.

And, though many on the left regard Summers as suspiciously conservative, that is hardly the case when it comes to inflation. His 1991 paper on monetary policy is widely cited as among the first to make the case for avoiding very low inflation targets, in part to give the central bank more room to lower interest rates.

Back then, Summers clearly viewed himself as a monetary-policy dove: “I would support having someone in charge of monetary policy who is more inflation-averse than I.”

But now Summers’s dovishness is not a problem. In the face of downward nominal-wage rigidity, higher inflation would facilitate sectoral adjustment and achieve a small but useful impact on reducing debt burdens.

If normal times call for a conservative central banker who helps to anchor inflation expectations, now is the rare time when we need a more unorthodox central banker who will fight deflation expectations.

Kenneth Rogoff, a former chief economist of the IMF, is professor of economics and public policy at Harvard University. Copyright: Project Syndicate, 2013.www.project-syndicate.org. Shanghai Daily condensed the article.

 

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