Greg Ip in the Wall Street Journal today:
Central banks have shown the will to hit their growth and inflation targets. But do they have the way?
That question is more pointed after the Bank of Japan on Wednesday announced two new central bank firsts. It now wants inflation not just to meet its 2% target, but to overshoot it. And it will now target not just short-term interest rates, but long-term government bond yields….Japan’s monetary travails matter to all central banks since so many countries are coming to resemble Japan, with slow growth and too-low inflation—factors that make it difficult for an economy to tolerate interest rates much above zero.
I suspect we’re learning something new: central banks can squash inflation by raising interest rates and causing a recession, but no central bank has ever tried to raise inflation. It’s simply been assumed that they have the power to affect inflation in both directions. But they don’t—at least, not in practice. I assume that if a central bank committed to flooding the economy with enough money it could, eventually, raise inflation rates, but no central bank is willing to go that far. And since it’s never been done, we don’t actually know for sure that it would work anyway. It might have side effects that trash the economy so badly that it wouldn’t be worth doing.
Pretty much every central bank in the developed world would like inflation to be higher, but not a single one has been successful at doing it. This suggests to me that in practical terms, inflation is a one-way ratchet. Central banks can reduce it, but they can’t raise it. I’m not entirely sure what this means, but economists need to come to grips with this apparent fact and figure it out.