Sunday, March 7, 2010

Trichet on Inflation Targets at 4 Percent (fg)

From the Q&A transcript:

Question: The IMF Chief Economist, Mr Blanchard, has suggested that central banks should consider higher inflation targets, at around 4%, in order to leave monetary policy more room to react to shocks like the financial crisis. What is your answer to him in this regard? His thinking was that the net cost of inflation at, say, 4% is not that much higher than at 2%. And also to anchor inflation expectations at 4% might not be that much of a problem, but you have more room to manoeuvre in the next crisis.

Trichet: I would say that it is plain wrong. That is my opinion and I believe it is the opinion of all central banks I know. First, it pays very little attention to the conclusions of academic research concerning the fact that at around 2% you probably minimise the counterproductive effects of inflation. Then I think it is totally counterproductive in the present period, when we have to cope with a difficult situation, to contribute to unanchoring inflation expectations. We ourselves have observed how extremely important it was to solidly anchor inflation expectations. By introducing such a change, you would drastically unanchor inflation expectations. And once you do that, of course, you suggest that any new change is possible, in any direction. So it is extremely dangerous. That is the second reason why I am totally opposed to that. Third, I think it would be very counterproductive in the present period of recovery, because it would have as an immediate consequence an increase in all medium and long-term interest rates, to incorporate the new inflation expectations, which would be tentatively 4% instead of less than 2% but close to 2 %. On top of the 2% increase which would be the arithmetic consequence of such a measure, you would also have to pay a risk premium because, if you start changing inflation expectations dramatically, the market can expect further changes. So the increase in market interest rates would be very high. Fourth, in a period when we have to remain as credible, well-anchored and as regards the financial environment, as favourable to growth and to job creation as required, it is clear that creating an inflationary shock could trigger an accelerated inflation phenomenon, which would be very dangerous. These are four reasons that I see immediately. I imagine I would find other reasons if we had more time to consider your question.