Inflation targeting is an extremely resilient policy. It survived an attempted lynching after the financial crisis, when a mob of economists such as David Blanchflower blamed it for the Great Recession. There was some introspection, but none of the method’s adherents changed course. In fact, the U.S. Federal Reserve made its inflation target more explicit. India this year adopted one.
The criticism of inflation targeting was that it bred complacency. Central banks acknowledged that perhaps they should be more open to using higher interest rates to deflate asset-price bubbles. Or not. A new IMF paper says that even slight divergence from a focus on price stability could be a mistake. “On balance, the case for leaning against the wind is limited,” the report concludes. The best evidence to date suggests the benefit of reducing the odds of a financial crisis rarely outweighs the cost of constraining economic growth. Credit and asset prices tend to rise with inflation. So a central bank that is focused on the cost of goods and services will automatically squeeze bubbles. If bubbles persist, authorities should try to pop them with targeted measures, the IMF report says. Higher borrowing costs should be a last resort.
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