What’s the Policy Playbook for the Inflation Endgame?
A single-minded approach to price stability is under threat as policymakers start to focus on what are—arguably—more pressing concerns. A shift in the inflation landscape is underway. But what will the new regime look like?
The notion of an “independent” central bank—where policy is set by technical experts, removed from the political process—has become one of the key tenets of good governance practice. But central banks do not operate in a vacuum. Ultimately, they will be judged by how much they help society achieve its goals. After the high inflation of the 1970s, the message for central bankers was very simple: keep inflation low. Central bank “independence” was a critical part of the political architecture to achieve that goal.
Now, that hawkish inflation message is blurring. The political balance is shifting, as governments try to repair the economic damage from COVID-19, combat inequality, make huge investments to mitigate climate change and manage record peacetime debt levels. Given these changes, what trade-offs will be applied? And will a return to the high inflation of the 1970s be the right template for the new inflation regime?
Several Moves Possible in the Inflation Endgame
Since the end of WW2, there have been three distinct global inflation regimes, with Japan’s experience hinting at a fourth (Display, below):
1) The immediate post-WW2 years, in which governments used fiscal policy to actively pursue their goals and mixed financial repression and inflation to help lower government debt
2) The 1970s, when inflation surged into double digits
3) The inflation-targeting era that started in the early 1990s, with widespread adoption of independence for central banks, formal inflation targets and the achievement of quasi–price stability (an annual inflation rate of 2.0%)
4) Japanification, with inflation fluctuating around zero and minimal levels of growth
Debt-Management Constraint Points to Higher Inflation Strategy