## Time for Change

## Source details

**Canonical URL:** [Time for Change](https://www.imf.org/en/publications/fandd/issues/2023/03/pov-time-for-change-masaaki-shirakawa)

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- [Markdown version](/en/publications/fandd/issues/2023/03/pov-time-for-change-masaaki-shirakawa/index.md)
- [Structured JSON version](/en/publications/fandd/issues/2023/03/pov-time-for-change-masaaki-shirakawa/index.json)
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## Bibliographic details
- Authors: Masaaki Shirakawa
- Published: March 1, 2023

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### 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*

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## Content in this bundle

- **F&D March 2023: Time for Change**
  - [F&D March 2023: Time for Change (Markdown version)](/-/media/files/publications/fandd/article/2023/march/shirakawa-time-change.pdf.md){rel="alternate" type="text/markdown"}
  - [F&D March 2023: Time for Change (PDF)](/-/media/files/publications/fandd/article/2023/march/shirakawa-time-change.pdf){rel="external" type="application/pdf"}

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_Source: https://www.imf.org/en/publications/fandd/issues/2023/03/pov-time-for-change-masaaki-shirakawa_