China should consider setting a formal inflation target

It’s not the breakneck expansion of that decade when the country’s GDP soared. Instead, an influential advisor to the central bank suggested the adoption of a compulsory 2%-3% inflation target. This was an idea that spread quickly in the last decade of the 20th century. 

New Zealand was an early mover. Soon came the UK and Australia. When the euro began life a few years later, the European Central Bank was handed a price-busting mission with a 2% target. The US Federal Reserve coalesced around that figure, but delayed a formal pronouncement until 2012.

Didn’t most policymakers who adhere to targets recently suffer from much higher inflation? Yes, and in large part, authorities failed to react sooner because price gains were consistently below their objective in pre-covid years. Central bankers wanted to be convinced that the surge in late 2021 was real. 

Also read: To revive the economy, China wants consumers to buy better stuff

The point is that aiming for a particular number drives policy—both up and down. Fans say that it adds predictability over the long run: If households and businesses know the inflation goal, then they will adjust their behaviour accordingly.

Like all approaches, this isn’t flawless. It beats punishing investors for a justifiably bearish perspective on the economy. China takes a dim view of the bond-market rally and has threatened to intervene to prevent yields dropping too low. Economists are being urged to refrain from using terms like “deflation." Colourful descriptions of market weakness can invite reproach.

China’s problem right now is the opposite of inflation. Consumer prices picked up slightly in July. While any increase is good news at this point, broad deflationary forces still predominate. Factory-gate prices extended a decline that began in 2022. 

This is a long way from what a former People’s Bank of China chief called a “central banker’s dream:" 2% inflation. Officials are clearly attracted by ideals behind a target. They have aimed for 3% in the past, though more as a ceiling, not necessarily something that must be met.

President Xi Jinping gets a lot of economic advice. Beijing is urged—or admonished—to boost consumer spending, rein in exports, curb overcapacity and clean up local-government debt. And please tackle the risk of deflation and be less timid in cutting interest rates. 

China has gone from guaranteed superior performance to being stuck with poor outcomes. Leaders typically bristle at what they see as Western critiques aimed at hampering the world’s second-largest economy, and some of them do fit that description.

That’s what makes comments from Huang Yiping, dean of the National School of Development at Peking University and a member of the PBOC’s monetary policy committee, so intriguing. 

While careful not to mention the D-word, Huang is clearly alive to the dangers of sluggish demand and floated the 2%-3% target. “The economy is now easy to cool, but difficult to heat up," Huang Yiping said. “If it really falls into the low inflation trap, the consequences will be serious."

Also read: What Xi Jinping gets wrong about China’s economy

A potential stumbling block is politics. Central-bank independence tends to go hand-in-hand with defined inflation objectives. If you are directing officials to hit goals, better they be free to do so without fretting about the political considerations that beset finance ministers and legislatures. 

An added advantage is that, if policy fails, the central bank can be hung out to dry. An independent anything in Beijing is problematic; Xi has consolidated power like no leader since Mao Zedong.

But that shouldn’t detract from the merit of the idea. There’s also room for nuance. The Bank of England, for example, was given an inflation objective in 1992, five years before the UK’s Tony Blair government bestowed autonomy. Politics isn’t divorced from borrowing costs even in the contemporary era. 

In Australia, the top bureaucrat at its Treasury is on its Reserve Bank board, and two respected former RBA chiefs have argued against changes that would remove the ability of the Cabinet to veto decisions. 

US Fed policymakers are wary of getting Congress offside. Former Fed chair Ben Bernanke took soundings on the target in 2009, and met with resistance, Sarah Binder and Mark Spindel wrote in their book The Myth of Independence: How Congress Governs the Federal Reserve. Bernanke would need to wait for more favourable conditions.

Also read: Deflation Worries Deepen in China

An inflation target for China along the lines of goals set elsewhere is a stretch. The substance of the idea shouldn’t be. Anaemic prices aren’t great for China and weigh on the global economy. ©bloomberg