For over a year I have been discussing the "fiscalisation" of monetary policy and the politicisation of central banking independence (some blithely question whether this is a concern in Australia). If there were any doubt, The Oz's senior economics correspondent, David Uren, sympathises with those who would tolerate higher inflation and a less independent central bank in his column today, entitled, "The RBA's inflation target not sacrosanct":
"[A]s Stevens and his colleagues travel to their regular meetings with peers from around the world at the Bank of International Settlements (BIS), they must be aware that inflation targeting is facing an unprecedented challenge.
Australia, with its healthy growth, low unemployment and still low government deficits and debt, can sail on regardless, but it is unlikely that inflation targeting would survive a new world downturn here or anywhere else in its current form.
The first line of attack, which emerged as the 2008-09 crisis was unfolding, was that simply targeting inflation did nothing to prevent ultimately destructive financial imbalances from building up...
In a world in which fiscal policy is dominant, the dogged pursuit of inflation targeting leads to more volatile inflation and higher sovereign risks...
[Morgan Stanley's] Pradhan says that while a country is trying to close large budget deficits, "monetary policy serves its inflation fighting credentials best by not fighting inflation aggressively".
The theory of inflation targeting said that it would be most effective with a conservative central banker whose ability to fight inflation credibly was reinforced by giving the central bank independence.
However, under large budget deficits, this approach is likely to prove disruptive. Pradhan cites the European Central Bank's decision to lift interest rates this year in the face of a weakening economy and massive sovereign debts as a destabilising influence.
He says that emerging market nations in both Latin America and Asia were able to emerge from financial crises in the late 90s by focusing on getting their budgets under control, while tolerating slightly higher inflation. "The fact that emerging market central banks were not quite as independent as their counterparts in the advanced economies actually helped," he says...
The IMF's Blanchard caused outrage early last year when he suggested that inflation-targeting central banks might do well to tolerate slightly higher inflation and interest rates.
He argued this would give central banks greater flexibility to lower rates during recessions without hitting the lower zero interest rate limit...
However, around the world, other central banks are dealing with the trade-off of fiscal and monetary policy. The Bank of England announced two weeks ago it would engage in a further round of quantitative easing, buying the government's bonds, at the same time as the inflation rate hit 5.2 per cent.
At the heart of the European crisis is the European Central Bank's reluctance to do anything more to ease the sovereign debt crisis than buy government bonds on the secondary market."
