Time for Change
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Bibliographic details
- Authors: Masaaki Shirakawa
- Published: March 1, 2023
Overview
- Argument: "It’s time to rethink the foundation and framework of monetary policy."
- Author: MASAAKI SHIRAKAWA, former governor of the Bank of Japan (2008–2013) and author of Tumultuous Times: Central Banking in an Era of Crisis.
- Context: Recent high inflation "not seen in 40 years" followed a period when central banks were "overwhelmingly concerned about low inflation" and often described inflation as "transitory."
Central failures and diagnostic themes
- Supply shocks and monetary policy:
- Triggering events—"trade and production disruption owing to the pandemic and the war in Ukraine"—were supply-side events but their inflationary impact "varies according to preexisting financial conditions, which are in turn shaped by monetary policy."
- Conclusion: "Central bankers, therefore, are not entirely blameless."
- Misplaced emphasis on the zero lower bound and deflation risk:
- Jay Powell (August 2020 Jackson Hole) framed the risk: "if inflation expectations fall below our 2 percent objective, interest rates would decline in tandem... we would have less scope to cut interest rates..."
- Counter-evidence from Japan: despite reaching the zero lower bound earlier, Japan's GDP per person growth "was in line with the G7 average from 2000... to 2012" and "growth of Japan’s GDP per working-age person was the highest among the G7 during the same period."
- Limits of unconventional policy:
- Bank of Japan balance sheet expanded "from 30 percent to 120 percent of GDP" after 2013 with only "modest" impact on inflation and growth.
- Unconventional tools can be potent depending on timing; example: forward guidance can be "too expansionary and inflationary" when the economy is hit by a surprise shock.
Political and historical considerations
- Political naiveté and central bank independence:
- Flexible average inflation targeting that "explicitly allowed inflation to overshoot the target" contributed to delays in tightening.
- Difficulty highlighted: "Is it possible in a democratic society for unelected central bankers to ask the government and legislators to trim the inflationary spending plans on which they were elected?"
- Great Moderation context:
- The "Great Moderation" (~20 years beginning mid-1980s) may have made central banking appear easier—"the prevalent narrative of successful monetary policy... may have come down to good luck and fortuitous circumstances."
- Favorable supply-side factors then included "the entry of developing and former socialist economies into the global market economy, rapid advances in information technology, and a relatively stable geopolitical environment."
- New headwinds: "heightened geopolitical risk, rising populism, and the pandemic" have disrupted supply chains and complicated unwinding of policy.
Rethinking the intellectual framework (three issues highlighted)
- 1) Reassess focus on deflation and the zero lower bound:
- Some economists propose a "higher inflation target" to allow "less additional tightening" and more margin of safety.
- Author's position: skeptical—additional room for rate cuts would not have materially altered the course after the global financial crisis; deflation is "a threat posed by a critical breakdown of the financial system."
- Implication: central banks must attend to financial institutions and markets, not only macro aggregates like inflation and the output gap.
- 2) Understand why central banks were forced into prolonged easing:
- Japan example: "stagnant growth due to structural factors—notably a rapidly aging and shrinking population—was misconstrued as cyclical weakness," leading to decades of monetary easing.
- Warning: prolonged monetary easing (over "10 years or more") can have adverse effects on productivity through "resource misallocation."
- Policy inference: "monetary policy became a quick fix for structural problems that required more radical reform."
- 3) Account for national differences in policy design:
- Labour- and social-contract differences affect inflation dynamics; example: Japan's "long-term employment" practice slows wage acceleration and thus inflation.
- Conclusion: "This undermines the case for a one-number-fits-all inflation-targeting strategy."
- Monetary anchor: must be a "firm commitment by the central bank to restrain inflation by monetary tightening and to be the lender of last resort" rather than simply setting an inflation target.
Key findings and implications for policy
- Central banks should:
- Reevaluate the primacy of deflation risk and the policy emphasis arising from the zero lower bound narrative.
- Monitor financial imbalances in institutions and markets alongside macro indicators.
- Avoid using monetary policy as a substitute for necessary structural reforms.
- Recognize that prolonged easing can harm productivity via resource misallocation.
- Tailor frameworks to national circumstances—wage-setting practices and social contracts matter for inflation dynamics.
- System-level takeaway:
- "Inflation targeting itself was an innovation... There is no reason to believe it is set in stone."
- The time is "ripe to reconsider the intellectual foundation on which we have relied for the past 30 years and renew our framework for monetary policy."
Masaaki Shirakawa, F&D Magazine, March 2023
Content in this bundle
- F&D March 2023: Time for Change