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Jeffrey Frankel, a Professor at Harvard’s Kennedy School of Government, argues for the importance of inflation expectations as a method to stimulate economic activity in a zero-bound interest rate world. This has been done by the US, Japan and the EU alike. But how did they set expectations? He claims that a sincere announcement by the Central Bank of a promise to aim at 2% target inflation, combined by quantitative easing acceleration, is a good strategy. However, it hasn’t fared so well – neither Japan nor the US have reached the target yet, despite low unemployment levels. A recent working paper that’s is also discussed in this article, however, argues to the contrary – setting inflation expectations has little effect on household and business decision making. Central Banker’s fixation on an inflation target might not be so necessary after all.
Why does this matter? Most economies are fixated on monetary policy as a primary stimulus tool and a 2% inflation target has been a long-standing holy grail. In a rock-bottom rate environment, it might be worth taking stock of why most countries struggle to reach that – and whether it should be a target at all.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)