Inflation, interest, money supply: Targets.

Inflation targeting, deflation, alternative targets, target changes, further reading.

Inflation targeting.

A serious difficulty about zero inflation is that it puts a floor under how far the real rate of interest – that is, the rate corrected for inflation – can fall.

(Samuel Brittan: Financial Times 06/06/02.)

. . . there is no way by which nominal interest rates can fall below zero; and in practice below some small positive amount. The result can be quite high real interest rates in a period of slump or recession. It was the inability of real interest rates to fall sufficiently in a slump that lay behind the Keynes liquidity trap and it has been a big factor in the current Japanese long-lived recession.

(Samuel Brittan: Speech to the Giersch Foundation, May 1999.)

. . . during the oil shocks of the 1970s, world economic activity was cushioned by the fact that prices continued to rise. This allowed US real interest rates to drop to nearly minus 5 per cent, and in the UK lower still. It is quite likely that if all industrial countries had followed a policy of trying to offset the rise in oil prices by reductions in other prices straight away, the recession of that period would have been worse than it actually was.

. . . The main emphasis of the IMF Outlook is . . . that if governments and central banks follow stable and responsible policies there would rarely be the type of recession which would need to be offset by negative real interest rates. The temptation is to respond: tell that to the marines. To put it more politely: boom and bust are most unlikely to be banished even though good policies may help to moderate them.

(Samuel Brittan: Financial Times 14/10/99.)

Ultimately, the main variable that central banks influence is the money supply. I am not suggesting that we should go back to a regime based entirely on monetary targets. But we should recognise that interest rate objectives are simply a poor proxy which have to be used because we do not know enough about movements of velocity or the appropriate monetary aggregates to target.

(Samuel Brittan: Remarks at Banque de France: Bicentennial Symposium, 30/05/00.)

The IMF has become so obsessed with inflation that it often seems to forget about growth and real stability.

. . . Increasing the unemployment rate makes workers worse off, but the resulting lower inflation makes bondholders happy. Balancing these interests is a quintessentially political activity, but there has been an attempt by those in financial markets to depoliticize the decision . . . The IMF has been encouraging, sometimes even forcing (as a condition of assistance), countries to have their central banks focus only on inflation.

(“Making Globalization Work”, Joseph Stiglitz, 2006).

The practice of inflation targeting looks increasingly like an outmoded experiment.

Britain adopted inflation targeting in 1992 after sterling’s ignominious exit from the European exchange-rate mechanism.

. . . It seemed to work . . . Inflation was low and growth was consistent. We know in retrospect, though, that this was not some great structural change in the Western economies. Low inflation was due in large part to cheap Chinese imports. And the much vaunted “end to boom and bust” turned out to be no such thing. The Bank met its inflation target but an asset-price bubble and expansion of consumer credit undermined financial stability.

(Oliver Kamm, The Times, 13 August 2013).

. . . the mandate of the European Central Bank is price stability . . . to bring inflation close to its 2 per cent target, not to boost growth and employment or bring about greater financial stability. . . This is not what many people in Europe hope for when thinking of a successful euro-wide macroeconomic policy.

(Emiliano Brancaccio and Giuseppe Fontana, Financial Times, 26 January 2015.)


A nominal income target is a policy conducted by a central bank that targets the future level of economic activity in nominal terms (i.e. not adjusted for inflation). The central bank could target Nominal Gross domestic product (NGDP) . . . and use monetary policy, including . . . interest rate targeting . . . quantitative easing or adjusting the interest rate on excess reserves to hit the target.

A . . . target of three percent is sometimes proposed . . . This target has the potential downside of being deflationary if real growth exceeds the three percent growth in nominal terms, implying a negative rate of inflation (i.e. deflation).


Economists generally believe that deflation is a problem in a modern economy because they believe it may lead to a deflationary spiral. Historically not all episodes of deflation correspond with periods of poor economic growth.


A large part at least of the deflation commencing in the 1870s was a reflection of unprecedented advances in factor productivity. Real unit production costs for most final goods dropped steadily throughout the 19th century, and especially from 1873 to 1896.


George A. Selgin . . . is one of the founders . . . of the Modern Free Banking school . . . which draws its inspiration from the writings of Friedrich Hayek on denationalization of money and choice in currency . . . Selgin is also known for . . . his advocacy of a “productivity norm” for monetary policy — a plan that would have policymakers target the growth-rate of nominal gross domestic product at a level that would allow the overall price level to decline along with goods’ real (unit) costs of production. . . According to Selgin, by preventing mild deflation in response to productivity gains, monetary authorities risk inadvertently fueling unsustainable booms or economic bubbles, setting the stage for consequent busts and recession.


. . . examples of . . . good deflation (1873-95) and bad deflation (1929-33.)  . . . nominal GDP did not fall in the former case, but did in the latter . . . it is the stability of nominal spending (domestic final demand), and not that of the price level per se, that is crucial to general macroeconomic stability.

(, 12 March 2009.)

I stick to my view that Friedmanite quantitative easing . . . is legitimate to prevent a collapse of the M3 broad money supply, and to prevent outright deflation in economies with total debt levels near or above 300pc of GDP. Not in any circumstances, but where necessary, and where conducted properly by purchasing bonds outside the banking system . . . The dangers of tipping into a debt compound trap – as described by Irving Fisher in Debt-Deflation Theory of Great Depresssions in 1933 – outweigh the risk of an expanded money stock catching fire and setting off an inflation surge later.

( Ambrose Evans-Pritchard, 27 September 2010.

The Fed deliberately popped the Wall Street bubble in 1928 and the Bank of Japan deliberately popped the Nikkei bubble in 1989-1990, only to find that boom-bust deflation can have its own unstoppable momentum.

. . . “Large banks are all offering money, but no one is taking it,” said a Shanghai dealer quoted by Reuters. This is more or less what happened in Japan in the 1990s, what is happening in Europe now. It is what happened to half the world in the 1930s. . . Woe betide the world if China does indeed land with a thud. We will then have a synchronised planetary slump for the first time since you know when.

(The last thing the world needs now is a deflationary shock from China.
Ambrose Evans-Pritchard, 9 July 2012.

In the early half of the past decade, inflation targeting made central banks reluctant to accommodate the deflationary effects of China’s entry into the world trading system. The excessive liquidity they created fed the credit bubble.

The time is ripe to reconsider monetary policy . . . to widen the range of monetary policy tools. . . change the inflation measure . . . change the target altogether . . . allow more aggressive action in slumps . . . let a monetary policy maker accommodate global price shifts instead of destabilising their own economy by trying to offset them.

(Financial Times, 13 December 2012).

Alternative targets, 2011-2012.

. . . commodity price indices in general are three times as high as they were at the beginning of this century and even non-energy prices are at a record. . . How should western central banks react if inflation rates in their countries continue to creep up above target? Certainly not by . . . trying to depress domestic prices to make up for rising prices for raw materials and fuel from outside their area.

. . . In the heyday of stable money in the 19th century there were several years of 5, 6 or even 7 per cent inflation. These were offset by other years when the price level actually dropped. The world gold standard made it unlikely that the value of money would be very different a couple of generations hence. In the meantime year-to-year variations had a function in coping with economic shocks. The gold standard was a regime rather than a set of targets. It will be difficult to get back to such a regime today. But at least we could dilute the possibly pernicious effects of inflation targets by giving other objectives equal stature.

(Samuel Brittan, Financial Times, 21 January 2011.)

. . . the monetary framework we have had in place since 1992. . . sterling had been forced out of the European Exchange Rate Mechanism . . . a new framework for monetary policy was needed. . . a numerical target for inflation in the medium term and the flexibility to respond to shocks to the economy in the short run . . . the framework became known as flexible inflation targeting.

. . . I want now to . . . ask whether monetary policy before 2007. . . should have been set differently during the period of the so-called Great Stability. . . With hindsight . . . there should have been a cap on the leverage of banks . . . That is why we now have a macro-prudential policy regime in the UK. It will be overseen by the Bank of England’s Financial Policy Committee, which will have the power to direct, and make recommendations to, regulators about capital and leverage in the UK financial system.

In my judgement, the big challenge to monetary policy before the crisis was a serious mis-pricing in long-term interest and exchange rates, and the imbalances that resulted. Much of this was outside the control of UK policy-makers and reflected developments in the world economy. . . it is vital that macro-prudential tools and micro-prudential regulation are part of the armoury of a central bank to mitigate, if not prevent, the build up of excessive leverage and risk-taking in the banking and wider financial sector.

. . . But . . . it would be optimistic to rely solely on such tools to prevent all future crises . . . there may be circumstances in which it is justified to aim off the inflation target for a while in order to moderate the risk of financial crises.

. . . In February 1929, Josiah Stamp went to Paris as a member of the Young Committee to assess whether the reparations debts run up by Germany could be repaid – the similarities with the present situation in Europe are too poignant to dwell on. In a letter to Keynes, Stamp compared these international meetings to a conjuror trying to pull a rabbit out of the hat:

“. . . One half . . . saying . . . there is a rabbit – there is. The other half try to make a noise like a succulent lettuce. There is a general conviction that the more eminent the conjurors convened, the more certainty . . . of the existence of the rabbit.”

(The Stamp Memorial Lecture. Twenty years of inflation targeting.
Mervyn King, Governor of the Bank of England, 9 October 2012.

Were the UK Treasury to set the Bank of England a target . . . for nominal GDP . . . many of the problems could be minimised. No one would have to pretend they knew how much slack there was in the economy or the precise supply capacity over the next two years. If supply was growing strongly, inflation would be lower and if not, it would be higher. But it would be contained in both cases. . . When you have very little idea what is going on, do not pretend otherwise but set sensible, simple rules . . . that are likely to avoid a catastrophe.

(Chris Giles, Financial Times, 20 September 2012).

The singular focus on inflation made sense in the 1980s, when rapidly rising prices were the biggest problem facing most economies.

. . . economists had strong incentives to come up with theories that proved unemployment was natural and inevitable, that macroeconomic policy could do nothing about it, and that the sole effect of monetary policy was on inflation.

. . . Any economist who suggested anything different . . . was laughed out of university economics departments, finance ministries and central banks. That purge is now over.

But although a revolution is under way in the attitude toward economic targets, discussion of the new tools needed . . . has hardly begun.

(Anatole Kaletsky, International Herald Tribune, 21 December 2012).

Alternative targets, 2013.

The Treasury has set up a unit to explore changes to the Bank of England’s remit as political pressure mounts for action to boost economic growth.

The small internal group has been created to examine whether there is a need to alter the Bank’s 2 per cent inflation target.

. . . Vince Cable, the Business Secretary . . . is the only Cabinet member to publicly endorse a change to the remit . . Last night he said: . . . “It would be useful to make more explicit the need to maintain output growth and to take account of different forms of inflation – imported and domestic – as well as asset inflation”.

Dr Cable also raised concerns about the FLS [Funding for Lending Scheme], under which the Bank provides banks with cheap funding in the hope that it will pass this on to companies and households.

Dr. Cable said: “It is crucial that the capital rules are applied as flexibly as possible to prevent the current negative impact on SME [small and medium enterprise] lending. We need to test to the maximum the argument put by the regulators that they are totally constrained by international rules.”

(The Times, 18 February 2013, Sam Coates and Sam Fleming.
“Treasury brains trust ready to change goalposts at the Bank”.)

For those of us trying to sort out the debate over economic “austerity”, there’s a limit to what can be learned by inspecting the credentials of the contending economists.

. . . I refer to the late James Buchanan . . . of the “Public Choice” school of economics and the 1986 Nobel recipient . . . and such anti-austerian Nobel laureates as Paul Krugman and Joseph Stiglitz . . . Their differences reflect not so much economic principles as deep-seated beliefs about how society should, and does, operate.

Krugman et al. place top priority on the short-term problem of alleviating unemployment. . . persistent unemployment shrinks the economy’s capacity to grow . . . Buchanan argued, though, that the same result comes from persistent mis-allocation of resources through outmoded but politically untouchable government programs.

. . . The only thing I’m sure of is that neither side can achieve the kind of scientific victory that, say, Copernicus won over the Ptolemaic model of planetary motion.

This ostensibly economic debate is being conducted amid uncertainty over such basic parameters as the multiplier effect of taxes and spending; the long-term impact of zero interest rates; and even “full” employment. . . It is also essentially about value judgments and trade-offs.

(Charles Lane, 20 May 2013. )

. . . the Chancellor of the Exchequer . . . on September 28, 1976 . . . applied to the International Monetary Fund for a loan.

On the same day . . . the Prime Minister James Callaghan told the Labour conference: “We used to think that you could just spend your way out of recession . . . that option no longer exists.”

Callaghan and Healey were announcing an intellectual surrender. Twenty years of economic policy, perhaps more, had failed. . . Abandoning the chase for full employment changed the game. Governments had been overinflating the economy and then turning to the unions to agree pay restraint.

. . . Last week something very similar happened . . . the leader and Shadow Chancellor of the Labour Party announced . . . that in office they . . . would have to start with the spending plans they inherited . . . the argument . . . once boldly made, that deficits don’t matter, has gone.

. . . adandoning a defence of high spending and high borrowing is an intellectual surrender of similar proportions to the one made in 1976.

(Daniel Finkelstein, The Times, 12 June 2013).

Theories about economic targets might be less complicated if economic long waves were understood. Wikipedia currently lists 3 groups of explanations for these. ( ).

The debt-deflation credit-cycle theory is promoted by some monetary reformers ( ), while capitalists and entrepreneurs tend to favour Schumpeterian technological innovation theory.

The third group, demographic theory, is the one that I like, because I think women’s roles are important. Long wave economic downturns may be caused by birth-rate cycles nearly two generations long. ( ).

(Alison Marshall, November 2013).

Target changes.

. . . Inflation targeting has not worked in recent years and, in so far as the target was hit in the boom years, it was only by hitting a narrowly defined measure of inflation . . . it may be time to consider other forms of targeting. The US Federal Reserve, in explicitly setting a target for unemployment last night, certainly appears to think so.

(Ian King, The Times, 13 December 2012).

Do you remember inflation? Probably not, if you’re under 30. Back in the 1970s, when America was printing dollars like confetti, and the UK banking system was near collapse . . . we had spectacular inflation. For the years 1974, 1975 and 1976, prices went up 24 per cent, 16 per cent and 17 per cent respectively.

. . . We had another round of inflation . . . in the late 1980s. . . Again, if you were a student or OAP on a fixed income, or if your wages were not going up in line with inflation, you suddenly got much poorer.

After that, governments decided to get inflation under control. . . in 1997, Chancellor Gordon Brown gave the Bank of England the job of curbing inflation free from interference by politicians . . . the financial bubble of 2003-2008 . . . in other words, asset inflation . . . subsequently exploded, creating the mess we are now in.

In 2009 . . . prices actually went down, as the economy imploded. In response, the Bank of England (with the connivance of the Treasury) started to print billions of pounds . . . But it is an economic house of cards that will collapse some day unless – magically – growth reappears. But, as we know from the new forecast . . . growth is not on the horizon.

So, on Wednesday, George Osborne changed the official mandate of the Bank of England. Henceforth, the Bank is responsible for promoting growth as well as curbing inflation. It will now be free to make “trade-offs” between curbing inflation (through higher interest rates) and promoting growth (through lower interest rates). And the Chancellor now has someone else to blame if growth does not appear.

The flaw in this clever scheme is that the Bank has already been making this inflation-growth trade-off, with little impact on the economy. The Bank is supposed to hold inflation at 2 per cent, yet prices have been accelerating faster than that for four years.

. . . the jury is out on whether George Osborne’s Budget was merely boring – or else harbinger of the return of the inflation monster.

(Anatole Kaletsky, The Scotsman, 22 March 2013).

The Bank of England’s . . . governor . . . said on Wednesday that the Monetary Policy Committee intended to keep interest rates at 0.5 per cent until unemployment drops to 7 per cent. The pledge is contingent on maintaining price and financial stability.

. . . Unemployment was chosen because, along with being easy for the public to understand, it is a reasonably reliable indicator of slack, or spare capacity, in an economy.

(Claire Jones, Financial Times, 9 August 2013).

A notable factor in Britain’s economic recovery has been that while unemployment has fallen rapidly, wage growth has been muted.

. . . Mark Carney, governor of the Bank of England (BoE) . . . is sensitive to accusations that the BoE’s rate guidance has led to confusion about when rates will go up . . . But . . . the only real U-turn on guidance was when the Bank dispensed with the reference point of a set unemployment rate . . . because this fell much more quickly than expected.

Since this was replaced by a more flexible touchstone of the amount of “slack” in the economy, taking into account multiple data, wage growth has consistently been an important consideration in the sights of the BoE’s monetary policy committee.

(Martin Flanagan, The Scotsman, 24 July 2014).

Further reading.

Inflation, interest, money supply: History.
Inflation, interest, the multiplier, broad money, quantitative easing.

Inflation, interest, money supply: Currencies.
Money-printing, currencies and trade, sectoral balances, Brexit.

Monetary sects.
Modern Monetary Theory, Positive Money, other monetary sects.

Positive Money.
Objections to a monetary reform campaign.