Policies to Fight the Risk of Deflation Jeffery Amato BIS 17 November 2003
Jan 18, 2016
Policies to Fight the Risk of Deflation
Jeffery Amato
BIS17 November 2003
Disclaimer
The views expressed are my own and are not necessarily those of
the Bank for International Settlements
Topics
1.Challenges from changes in the inflation process
2.The role of financial imbalances
Key Fact #1
Inflation is lower and more stable
Low and stable inflation is good!
High and variable inflation have direct costs
Stable inflation achieves other goalsStandard view:
– Changes in inflation reflect demand and supply imbalances
– Inflation is a sufficient statistic
Challenge for policy:
Is inflation still a reliable indicator of underlying
imbalances?
Inflation as an Indicator
Role as an indicator depends upon pass-through of demand pressures
Indicator properties are affected by:– Credibility of monetary policy– Dispersion of information in economy– Competitive pressures
Changes in these factors may have distorted the signal quality of inflation
What does this have to do with deflation risk?
Imbalances might develop even if monetary policy succeeds in controlling inflation
If left unchecked, financial imbalances might eventually have a depressing effect on the real economy– Gears of financial system may get “jammed”– Period of prolonged deflation may ensue
Implications for Monetary Policy
Increased importance of central bank communication policies
Search for alternative indicators of growing imbalances
– A more prominent role for financial variables??
Key Fact #2
Greater prominence of financial booms and busts
Background Structural Change
Low and stable inflation
Greater fiscal discipline
Financial liberalisation and globalisation
Challenge for Policy:
Can monetary policy combat financial imbalances?
Issues
1. Identification of imbalances
2. What kinds of pre-emptive policies?
3. Other challenges
1. Identification of imbalances
Are past trends a reliable benchmark?– E.g. how to gauge changes in trend productivity??
Joint imbalances matter– Credit growth and asset prices (stocks, real estate)
1. Identification of imbalances
Are past trends a reliable benchmark?– E.g. how to gauge changes in trend productivity??
Joint imbalances matter– Credit growth and asset prices (stocks, real estate)
2. What kinds of pre-emptive policies?
Deflationary risk -> longer horizon
Greater role attached to financial imbalances– Predictive power for financial crises,
which have large real costs
Case Study: Japan and United States
Recent Japanese experience -> relevance for assessing deflation risk
Benchmark: policies focused on inflation and output gap variables
Taylor rule:
– Policy rate responds to:• Inflation minus target• Output gap• Long-run real interest rate
What About Other Indicators?
Other factors may explain deviations from benchmarks– Financial headwinds??– Japan:
• Structure of banking sector• Non-performing loan problem
– United States:• A more robust financial sector?
3. Other Challenges
Political economy– Can the central bank raise rates when inflation is low?
Is interest rate policy enough?– Again, role of communication– Co-ordination of policies?• Regulatory, fiscal?