The job of pulling the world economy out of the woods is increasingly getting shifted to the shoulders of central bankers. One example is that of the Ben Bernanke-led US Federal Reserve, which has decided to expand its balance sheet at an unprecedented rate till the unemployment rate is down to 6.5% from the current 7.7%.
Another one comes from Japan where the prime minister-elect Shinzo Abe wants the Bank of Japan to increase its inflation target to 2-3%—in effect exhorting it to print more money in order stimulate demand. It is hoped this will pull down the value of yen and push exports. Meanwhile, Mark Carney, the boss of the Canadian central bank who will take charge of the Bank of England in 2013, has talked about a “flexible policy approach”. And not to be left behind, Mario Draghi of the European Central Bank has anyway promised to do “whatever it takes” to the save the euro.
At one level, what these central bankers are trying to do now is to play with the trade-offs inherent in the short-run Phillips Curve. Named after the economist A.W. Phillips, this is an empirically observed relationship between the rate of unemployment and the rate of inflation.
In the 1960s, it suggested a policy trade-off between lower unemployment and higher inflation or vice-versa, depending on a society’s preferences. Its theoretical underpinnings were weak to begin with. The age of “stagflation” (in the 1970s) led to a questioning of its policy utility as well. Central bankers targeting the rate of unemployment is a return to pre-stagflation thinking. It is also of doubtful value.
First, those trade-offs worked in a world in which “financialization” was practically non-existent. Second, it is not clear how these unemployment objectives will be attained. Western central banks have declared an ultra-loose monetary policy for an extended period of time. That is not working. It has not led to a pick-up in employment. It is not clear what else can be done. In the end, these are strategies of despair.
Getting out of this ultra-loose monetary policy will not be as easy as it is getting into it. Furthermore, a similar experiment of targeting unemployment did not work in the US in the 1970s. Central bankers need to be cautious and not get carried away with their new-found targets.
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