Wednesday, May 9, 2007

Sarkozy – Meddling with inflation targeting

European finance ministers have asked French president elect Sarkovky to back-off from talk about changing the policy objectives of the ECB. It is interesting that this tussle is coming after a period of very effective monetary policy. Instead of monetizing the oil price shock of the last few years, central banks have held fast to their inflation targeting objectives. It is also interesting to see many politicians back independence. This could be a sign of monetary enlightenment.

This steadfast approach may have, in the short-run, cost jobs in Europe which still has relatively high unemployment, but much of this unemployment is due to structural policies within Europe. While the EU has widened, economic benefits have been dispersed based on the productivity differences across countries and their ability to adapt to changing global trade flows. A centralized monetary policy will have differential impact especially if there is not feee flow of capital and labor across all borders. None the less, this is not a reason for changing policy objectives.

Should the ECB change its policy objectives? Theory suggests that central banks have generally been unsuccessful at sustaining growth as well as controlling inflation, but it is a political question of whether people want to change focus.

In the United States, the dual target of growth and controlling inflation has caused considerable confusion. The current discussion of whether the Fed should ease in response to housing problems has caused more uncertainty than any discussion on the core inflation rate over the last six months.

The fight for independent central banks was a long and hard one. We hope that there will be minimal meddling with central banks by politicians, but discussion on this issue is relevant. The hegemony of inflation targeting and independence should be discussed if for no other reason than to affirm good policies.

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