Don't give up on inflation targeting just yet

The Money, Macro and Finance Research Group (MMF) annual policy conference is one of the best places to gain an overview of current issues in monetary policy and I was fortunate to attend this year’s event to hear presentations from the likes of St Louis Fed President Jim Bullard, former Fed Board member Frederic Mishkin and Riksbank governor Stefan Ingves (and not forgetting a useful contribution from the MPC’s ever-thought provoking Gertjan Vlieghe). Mishkin’s presentation won the prize for the most entertaining. In addition to being a very accomplished speaker, his was the first presentation I have heard which incorporated a reggae track, produced by the Bank of Jamaica to highlight its new inflation targeting regime (here – and it’s well worth a look).

There were a significant number of issues raised and I will undoubtedly come back to many of them in the course of future posts. If there was an overarching theme from the whole event, it was the general agreement that monetary policy has reached the limits of what it can do to support the economy without some additional fiscal support. Not that central bankers would ever admit they are out of bullets, but it seems obvious they cannot go on doing what they are doing in the expectation that things are going to change. There was also a lot of head-scratching as to why inflation continues to undershoot central banks’ 2% target and Mishkin’s presentation on inflation targeting is a good starting point to think about the inflation framework adopted by most central banks.

In my view, Mishkin started from the wrong place. He started by pointing out that inflation in the Anglo Saxon world started falling in the early-1990s at the same time as central banks began to directly target inflation. Although he did not say so in as many words (although it was explicitly stated by some in the audience), the underlying message was that central banks’ focus on reducing inflation was the key factor in quelling the rampant inflation of the 1970s and 1980s. This idea has been bandied around by numerous central bankers over the years, although it is heard less frequently today. And with good reason: it is far from the whole truth.

Inflation expectations took a battering following the early-1990s recession, the second in a decade, whilst intensified competition – itself the product of the 1980s deregulation regime – also acted to depress expectations. I heard nothing about the impact of the end of the Cold War or the rise of China, both of which increased the global economy’s productive capacity with consequent dampening effects on inflation. The reason why such denial may be a problem is that if central bankers really believe they have curbed inflation, when in fact it is largely the product of exogenous forces, they may not be best equipped to force it back towards target and may understand the inflation process less well than they think.

This raises another question. If inflation is persistently below target, what is the point of maintaining the target? In the case of the ECB, for example, CPI inflation has averaged 1.0% since 2013 which is well below the target rate of below, but close to, 2%. In order that the ECB’s inflation rate averages 1.9% over the ten-year period 2013 to 2022, it would have to average 3.9% between now and December 2022. Such arithmetic has prompted luminaries such as Olivier Blanchard, the IMF’s former chief economist, to suggest raising central bank inflation targets to 4%. But there are good arguments against such a strategy.

In the first place, it is more difficult to stabilise inflation at 4% than 2% because the former figure is not consistent with the definition of price stability in which inflation is not a big factor in economic decision-making. An inflation rate of 4% implies that the price level doubles every 17.5 years versus 35 years in the case of 2% inflation. If you are making long-term calculations, such as investment or pension planning, there is a big difference between these two figures. Moreover, once we start to deviate from a 2% inflation target, why stop at 4%? Why not raise the target to 6% or 8%? Before too long, we could very easily get back towards 1970s territory.

But there is an argument suggesting that central banks could allow temporary deviations from the 2% target. Rather than target the inflation rate, an alternative would be to target the price level on (say) a two-year horizon. One of the disadvantages of targeting inflation (i.e. the rate of change of prices) is that shocks which impact on prices – and therefore temporarily raise the inflation rate – become fully embedded in the price level. But in a price level targeting regime, they are not.

We can illustrate this graphically (below). Consider the case where there is a shock to prices which causes them to fall by 1.5%. If the central bank does not attempt to compensate for this, in the knowledge that this is a one off impact, the price level is permanently lower and the rate of change eventually rises back to the 2% target (grey line). But if the central bank attempts to restore the price level to its steady state path on a 2-year horizon, it can tolerate much higher inflation and it is only three years after the initial shock that the inflation rate returns to the steady state rate of 2% (black line). One clear advantage of this regime is that it acts as an anchor for long-term price levels, and thus provides more certainty for inflation rates used as a basis for long-term wage and pricing contracts.

This sounds good in theory but does it work in practice? Much of the literature is based on the assumption that inflation expectations adjust relatively quickly and in a pre-defined manner. However, the experience of the last decade suggests that expectations adjust much more slowly than is often assumed. Nor do we know the functional form of the expectations formation process. This means that central banks may have to allow inflation to run further ahead of target for longer than they would like in order to give time for expectations to normalise. This in turn runs the risk that central banks may be perceived as having made a permanent adjustment to their inflation target.

Much as we may be critical of central banks which bang on about their target even though inflation continues to deviate from it, the constant repetition serves a purpose of reminding us that this target exists. If they stop talking about it, we might start to pay less attention to it and eventually forget about it altogether. And if we get to this point, there is a real fear that expectations could become unanchored and move around wildly as economic conditions change.

You might argue that in a world of exceptionally low inflation, there is no need to worry about any pick up in the pace of price growth. But central bankers can counter, with some justification, that just as the exceptionally high inflation of the 1980s quickly gave way to lower inflation within the space of five years, so the process could just as quickly run the other way. It is thus important to try and ensure that expectations remain anchored and it may be too soon to call for radical changes to the inflation framework.

Inflation beliefs

One of the biggest apparent puzzles in macroeconomic policy today is why inflation remains so low when the unemployment rate is at multi-decade lows. The evidence clearly suggests that the trade-off between inflation and unemployment is far weaker today than it used to be or, as the economics profession would have it, the Phillips curve is flatter than it once was (here). But as the academic economist Roger Farmer has pointed out, the puzzle arises “from the fact that [central banks] are looking at data through the lens of the New Keynesian (NK) model in which the connection between the unemployment rate and the inflation rate is driven by the Phillips curve.” But what if there were better ways to characterise the inflation generation process?

Originally, the simple interpretation of the Phillips curve suggested that policymakers could use this trade-off as a tool of demand management – targeting lower (higher) unemployment meant tolerating higher (lower) inflation. However, much of the literature that emerged in the late-1960s/early-1970s suggested that demand management policies were unable to impact on unemployment in the long-run and that it was thus not possible to control the economy in this way. The reason is straightforward – efforts by governments (or central banks) to stimulate the economy might lead in the short-run to higher inflation, but repeated attempts to pull the same trick would result in a response by workers to push for higher wages which in turn would choke off labour demand and raise the unemployment rate. In summary, government attempts to drive the unemployment rate lower would fail as workers’ inflation expectations adjusted. One consequence of this is that the absence of any such trade-off implies the Phillips curve is vertical in the longer-term (see chart).

Another standard assumption of NK models, which are heavily used by central banks, is that inflation expectations are formed by a rational expectations process. This implies some very strict assumptions about the information available to individuals and their ability to process it. For example, they are assumed to know in detail how the economy works, which in modelling terms means they know the correct structural form of the model and the value of all the parameters. Furthermore they are assumed to know the distribution of shocks impacting on the economic environment. Whilst this makes the models intellectually tractable, it does not accord with the way in which people think about the real world.

But some subtle differences to the standard model can result in significant changes to the outcomes, which we can illustrate with regard to some recent interesting work by Roger Farmer. In a standard NK model the crucial relationship is that inflation is a function of expectations and the output gap, and produces the expected result that the long-run Phillips curve is indeed vertical. But Farmer postulates a model in which the standard Phillips curve is replaced by a ‘belief’ function in which nominal output in the current period depends only on what happened in the previous period (known as a Martingale process). Without going through the full details (interested readers are referred to the paper), the structure of this model implies that policies which affect aggregate demand do indeed have permanent long-run effects on the output gap and the unemployment rate, which is in contrast to the standard NK model. Moreover, Farmer’s empirical analysis suggests that the results from models using belief functions fit the data better than the results derived from the standard model.

The more we think about it, the more this structure makes sense. Indeed, as an expectations formation process, it is reasonable to assume that what happened in the recent past is a good indicator of what will happen in the near future (hence a ‘belief’ function). Moreover, since in this model the target of interest (nominal GDP) is comprised of real GDP and prices, consumers are initially unable to distinguish between real and nominal effects, even though any shocks which affect  them may have very different causes. In an extreme case where inflation slows (accelerates) but is exactly offset by a pickup (slowdown) in real growth, consumers do not adjust their expectations at all. In the real world, where people are often unable to distinguish between real and price effects in the short-term (money illusion), this appears intuitively reasonable.

All this might seem rather arcane but the object of the exercise is to demonstrate that there is only a “puzzle” regarding unemployment and inflation if we accept the idea of a Phillips curve. One of the characteristics of the NK model is that it will converge to a steady state, no matter from where it starts. Thus lower unemployment will lead to a short-term pickup in wage inflation. Farmer’s model does not converge in this way – the final solution depends very much on the starting conditions. As Farmer put it, “beliefs select the equilibrium that prevails in the long-run” – it is not a predetermined economic condition. What this implies is that central bankers may be wasting their time waiting for the economy to generate a pickup in inflation. It will only happen if consumers believe it will – and for the moment at least, they show no signs of wanting to drive inflation higher.

Monetary policy complications

A couple of months ago I wrote a post (here) which posed the question whether we knew what was really driving inflation. Last month, Claudio Borio, head of the Economic and Monetary Department at the BIS, delivered a speech (here) asking a similar question. Borio raised three key issues:

1. Is inflation always and everywhere a monetary phenomenon, as claimed by Milton Friedman? Or do real factors play a much bigger role than often assumed? 
2.  Are we underestimating the influence that monetary policy has on real interest rates over longer horizons?
3. If these two claims are true, does it then follow that central banks should place less emphasis on inflation in designing monetary policy, and more on the longer term effects of monetary policy on the real economy through its impact on financial stability?

In short, Borio's answer to these questions is broadly yes. In the case of (1) he argues persuasively that the forces driving inflation are increasingly global, rather than local, with technological change and the entry of billions of new workers into the global workforce as a result of globalisation being primary contributory factors. Ironically, the economics profession generally believes that immigration has little impact on local wages but that raising the global supply of labour impacts upon global wages. That is a circle which needs to be properly squared.

With regard to (2), Borio uses a range of historical examples to indicate that the impact of monetary policy, via its influence on expectations, can have far longer-lasting implications on the real economy than is conventionally supposed. In other words the neutrality of money, which forms a key assumption underpinning much of modern macroeconomics, can be called into question. The logical conclusion is thus that a monetary policy purely focused on inflation can have dangerous side effects which cannot be ignored. Indeed, Borio argues for the "desirability of great tolerance for deviations of inflation from point  targets while putting more weight on financial stability."

I find this set of arguments highly convincing. Indeed, it is difficult to dismiss the thought that QE, which reduces interest rates and prompts a bubble in the price of other assets, ultimately impacts upon decision making in the real economy. For example, it prompts indebted firms to issue additional debt to fund capital expansion – hence the boom in the high yield debt market – which may ultimately come to a sticky end if interest rates start to rise.

A further suspicion is that the current monetary policy model is merely the latest in a long line of fads which may well be junked when (or if) it proves not to work. This chimes with the view expressed by Charles Goodhart[1] who has pointed out that since the 1950s there have been broadly three fashions in policy. From the 1950s to the mid-1970s, monetary policy was focused on labour markets and the bargaining power of unions. As the economics profession increasingly realised that simple Phillips curve analysis was insufficient to explain the relationship between inflation and unemployment, policy between the late-1970s until the 1990s switched to looking at money and monetary aggregates. But as this approach also failed to deliver control of inflation, the thrust of central bank policy switched to the NAIRU and the influence of expectations. But if Borio is right, this may simply be another in the long line of transitory policy fashions if it proves to have adverse longer term consequences which require more rapid-than-desired policy adjustment.

Indeed, central bankers will readily agree in private that they do not know what are the long-term implications of the current monetary approach. In particular, the impact of low interest rates on depressing pension returns is a problem which will only become apparent over a multi-year horizon. In effect, society has been forced to choose between protecting employment and labour income today at the expense of lower pension returns tomorrow. The jury is out as to whether it is a worthwhile trade off.

The question of whether the BoE should raise interest rates in the near-term should be seen in this context. On the one hand, there is a strong case for suggesting that rates are too low given the overall macroeconomic picture which is helping to exacerbate asset price distortions. But it is less clear that inflation should be the trigger for higher rates. Admittedly, inflation is running well above the 2% target. But wages remain muted and given the backdrop of Brexit-related uncertainty, they are likely to remain so.

It is hard to avoid the suspicion that justifying a monetary tightening on the back of inflation is a convenience which the general public can readily understand. Whilst households may not like it, higher rates may in fact be in the best interests of the economy. Not because there is an inflation problem, but because it might be the first step on the road towards taking some of the air out of the asset bubble which has built up in recent years. It may also help to give us a little bit more retirement income too.

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[1] Goodhart, C. (2017) Comments on D Miles, U Panizza, R Reis and A Ubide , “And yet it moves – inflation and the Great Recession: good luck or good policies?”, 19th Geneva Conference on the World Economy

Do we know what drives inflation?

A few years ago, I recall attending a seminar in which a microeconomist gave a fascinating presentation explaining how supermarkets set prices. The process involved looking at margins and assessing competitors actions in order to set prices sufficiently low as to attract custom but high enough to generate decent revenue. This was followed by a presentation from a macroeconomist outlining the standard macro model of inflation involving inflation expectations, output gaps and employment conditions. The contrast between the two notions was so stark that it was at this point I realised that economists do not fully understand the inflation generation process.

I should qualify this: Obviously, we broadly understand the principles of inflation but in practice we run into difficulties. It is generally believed that inflation is, to quote Milton Friedman, always and everywhere a monetary phenomenon. For obvious historical reasons many German economists, and indeed many elsewhere, still believe that excess monetary creation will lead to a rapid pickup in prices (I recall hearing a prominent monetary economist saying in 2009 how QE would lead to higher inflation within months). However, this model was largely discredited in the Anglo Saxon world during the early 1980s when the naïve quantity theory of money was debunked by the fact that monetary velocity was found to be unstable. In other words, the ratio between GDP and monetary aggregates changed due to the financial deregulation taking place at the time, which reduced the usefulness of monetary targeting as means of controlling inflation.

We should not dismiss monetary theories of inflation completely because, as the German hyperinflation of the 1920s demonstrated, a huge increase in the supply of money will reduce its value. But in the western world over the past eight years we have had one of the most aggressive periods of monetary easing in history without any significant pickup in inflation. Why?

Central banks’ quantitative easing policy which injected huge amounts of liquidity into the economy did not result in a wider spillover into prices because: (i) the liquidity was deposited in a banking system which at the time was not best placed to distribute it more widely throughout the economy; (ii) the liquidity was delivered directly to asset holders who sold bonds to the central bank, and it did not accrue to households and businesses and (iii) there was plenty of spare capacity in economies, with demand muted and the private sector engaged in deleveraging, with the result that we never got into a situation where too much money was chasing too few goods. Thus the conditions for the simple monetarist model of inflation have not held in recent years.

It is also the case that the pre-crisis literature was based on relatively closed economic systems, in which economies would more quickly run into capacity limits. In today’s globalised world that is no longer true, and the rise of China as an economic superpower has hugely increased global productive capacity. As a result, global production costs and prices have been driven down, which has encouraged consumption. Economies such as the US and UK are more likely to experience a rising external deficit as a symptom of excess demand, rather than rising prices as once would have been the case.

The Japanese case is perhaps the most extreme example of an economy which has failed to generate inflation, despite the best efforts of the central bank to get it back towards 2%. The BoJ continues to buy huge quantities of securities, sending its balance sheet to 90% of GDP in the process. No thought has been given to the longer term consequences of this policy, but suffice to say that if the BoJ were forced to run down its balance sheet, the effects on markets would be dramatic. I have long believed that the Japanese policy of trying to push up inflation is misguided in an economy where an ageing population is reliant on its savings. It does seem odd that the central bank is engaged in a policy which has not worked for 16 years and does not appear likely to do so anytime soon. It is probably a measure of desperation that it does not know what else to do. Unfortunately, the higher it drives the balance sheet today, the more difficult will be the process of unwinding it in future – all the more so if it does not generate the desired inflation.

There is not one single reason why inflation remains so muted. I suspect that structural changes are helping to depress inflationary forces – globalisation; the effects of the recession on inflation expectations and the substitution of capital for labour to name but three. Our standard inflation models, in which tight labour markets and excess liquidity creation will lead to higher prices, are currently not working. This is not to say they never will again. It is just that for the foreseeable future, we are going to have to learn to live with lower inflation.

There are pros and cons of such a situation. On the plus side, we will be spared the destabilising effects of a 1970s-style pickup. But it also means that we will find it harder to run down our debt burdens than we have become used to, and that might be one of the reasons why people feel more miserable than they once did. Back in the day, we used to construct misery indices as the sum of unemployment and inflation rates: the higher the index, the more “miserable” we are, but as the chart shows, the UK misery index is near to multi-decade lows. Maybe what we need is a dose of inflation (especially wages). Quite how we can generate that is a matter of much debate.

Mr Phillips is resting

Markets are increasingly concerned that central bankers may be about to take away the punch bowl rather earlier than they had previously anticipated. The Bank of Canada was the latest central bank to tighten policy, raising rates by 25 bps this week for the first time since 2010. There is also increased nervousness regarding the policy intentions of the ECB and BoE. But whilst there are good reasons for taking away some of the emergency easing put in place in the wake of the financial crash of 2008-09, it is proving much harder to justify tightening on the basis of inflation than most had expected.

This is a particular problem for the Fed which has nudged up the funds rate in four steps of 25 bps over the past 18 months, but is reliant on signs of higher inflation to justify ongoing policy normalisation. US core CPI inflation, which was running above the Fed’s 2% target rate last year, slipped back to 1.7% in May and June and is thus at the bottom end of the range in place since 2011. Wage inflation has also picked up, but here too the acceleration has been modest, with hourly earnings running at an annual rate of 2.8% in June which is only 0.5 percentage points higher than the average of the last three years.

For an economy which is running close to what appears to be full employment, this might appear rather surprising. But the headline unemployment rate, currently 4.4%, understates the degree of slack in the US labour market. The so-called U6 rate which adds in “marginally attached” workers – defined as “those who currently are neither working nor looking for work but indicate that they want and are available for a job and have looked for work sometime in the past 12 months” – is still at 8.6%. This is slightly higher than the previous cyclical trough in 2007 when it reached 8.0%, and significantly above the low of 6.8% recorded in October 2000. Arguably, therefore, the jobless rate can still fall a little further before wage and price inflation starts to become more of an issue.

The UK shows a similar – indeed, perhaps more extreme – picture with the unemployment rate in the three months to May at its lowest since 1975 whereas the rate of wage inflation, at 1.8%, is a full percentage point below that recorded last November. As in the US, there is a significant amount of spare capacity in the labour market. Currently, 12% of those working in part-time employment are doing so because they cannot find full-time employment. Whilst this is down from a peak of 18.5% in 2013, it is still higher than the 8-9% range recorded before the recession of 2008-09 and points to a certain degree of involuntary underemployment. This in turn suggests that there have been structural changes in the labour market which have impacted on the traditional relationship between headline unemployment and wage inflation.

For many decades, economists have focused on the negative relationship between wage inflation and unemployment first postulated by Bill Phillips in the 1950s. In its simplest form, this suggests that policymakers face a trade-off between unemployment and inflation. In practice, the relationship holds only in the short-term, if at all. What is notable, however, is that in the UK and US there has been a flattening of the curve in recent years, suggesting that any negative relationship between wages and unemployment is even weaker today than in the past. 

This is illustrated for the UK in the chart below, based on an idea presented in Andy Haldane’s recent speech entitled “Work, Wages and Monetary Policy.” The chart shows the trend derived from a linear regression of wage inflation on the unemployment rate over various periods. Two features are evident: Most obviously, the line has moved down reflecting the fact that over time inflation in the UK has fallen. But it is also notable that the slope of the line has become shallower. In other words, UK wage inflation has become less sensitive to changes in the unemployment rate. To illustrate the implications of this, we assess the wage inflation rate consistent with an unemployment rate of 5.5% and how this would change if unemployment fell to 4.5% (current levels).

The results are shown in the table (below). Simply put, an unemployment rate of 5.5% would be associated with wage inflation of 14% on the basis of the relationship over the period 1971-1997, falling to 4.1% between 1998-2012 and just 2.1% on the basis of the data for 2013-2016. But what is also interesting is a one percentage point fall in the jobless rate to 4.5% has a much smaller impact based on recent years’ data than in the pre-recession period. For example, this might have been expected to produce a 0.9 percentage point rise in wage inflation over the 1997-2012 period compared to a 0.5pp rise based on recent data.

Space considerations preclude a look at the reasons for the weaker sensitivity of wage inflation to labour market conditions. It may be the result of factors such as a lower degree of unionisation; the more widespread use of zero hours contracts and the rise of the gig economy, all of which have raised the degree of slack which the headline unemployment rate does not capture. But what the analysis does suggest is that policymakers can afford to spend less time worrying about the impact of low unemployment on wage inflation. There may be a case for higher interest rates but it is not to be found in the labour market.

As a final thought, I am struck by certain parallels with Japan. Following the bursting of the bubble economy, the Japanese authorities failed to spot the structural factors which led the economy to the brink of deflation, notably an ageing demographic profile which prompted a switch towards saving rather than consumption. The one factor we might be missing today is the impact of automation, which threatens a significant substitution of capital for labour and which could put downward pressure on the relative price of labour. I would thus not be in a hurry to raise interest rates to counter a wage inflation threat which has so far failed to materialise.

Central banks face an inflation dilemma

Over the course of recent weeks there has been a shift in the message communicated by monetary policy makers. The monetary authorities on the other side of the Atlantic have long been ahead of their European counterparts, with the Fed having raised rates four times since December 2015 and three times in the last six months. But it has now gone further and announced in mid-June that it “expects to begin implementing a balance sheet normalization program this year, provided that the economy evolves broadly as anticipated.” A week prior to that the ECB changed its assessment of the balance of economic risks to “balanced” rather than “tilted to the downside” whilst only last week, Norges Bank removed its previous guidance that interest rates could be cut this year. Also this month, the Bank of England only narrowly voted to hold rates at their all-time low of 0.25% with three members of the Monetary Policy Committee pushing for a 25 bps rate hike.

The narrowness of the BoE vote came as a surprise with the dissenters concerned that inflation had overshot relative to expectations, reaching a four year high last month, at the same time as the margin of spare capacity in the economy has clearly diminished. My initial reaction to this reasoning was that it was flawed: Inflation has surged largely because of the impact of currency depreciation and so long as this does not impact markedly on inflation expectations, which leads to faster wage growth, the BoE may simply have to swallow the problem. Indeed, with wage growth slower today than before the EU referendum, higher interest rates at a time of falling real wages will not do anyone any favours. That said, with the unemployment rate close to the BoE’s estimate of the NAIRU, such concerns are understandable.

My own view is that the uncertainties surrounding Brexit will suffice to keep UK inflation expectations in check for some time to come. Indeed, across much of the industrialised world, it is proving difficult to drive up inflation: In both the US and euro zone inflation is struggling to reach the central bank’s 2% target – a trend which will not be helped by the recent decline in oil prices which has supported headline inflation in the past year. Although central banks have a mandate to control inflation, and in many cases have to meet particular targets, it is difficult to explain to the wider public that there is no automatic link between price growth and interest rates – just as there is not, and never has been, one between inflation and money supply growth, despite the best efforts of many politicians and (some) economists to convince us otherwise. As if we needed proof, consider the case of Japan where despite running a balance sheet equivalent to 90% of GDP – almost four times that of the Fed, ECB or BoE – inflation has only exceeded the BoJ’s 2% target for three months during this century (once we strip out the distortionary effects of consumption taxes, see chart).

There are numerous reasons why inflation today is much lower than during previous periods when prevailing economic circumstances were similar. A much more globalised economy, in which value chains stretch across international borders has been one of the key factors holding down price inflation over the past decade. This has been accompanied by technological change which has depressed wage expectations. In effect, the pricing power of labour has been reduced as wages are increasingly set according to international conditions rather than those in local labour markets. Moreover, as the BIS reminds us in a message that too many economists often overlook, “wage growth is not necessarily inflationary: whenever it is supported by productivity gains, it will not lead to rising production costs.” And as I never tire of pointing out, although the UK’s productivity record has been dismal since the great financial crisis, it has still been stronger than real wage growth.

In an environment where the link between the domestic economy and wages has weakened, this makes it difficult for central banks to justify raising rates based on the threat of more rapid potential wage growth. But low interest rates have contributed to the asset bubble which has forced – or perhaps facilitated – investors to take risks in order to generate faster rates of return. Some form of monetary tightening is thus desirable. It is for this reason that the BoE today announced that it will raise banks’ countercyclical capital buffer – a measure of mandatory additional capital holdings – from zero to 0.5%, with a view to raising it to 1% in November in a bid to curb excess credit growth.

I must confess to some mixed feelings on the situation we now find ourselves in. On the one hand, central banks are concerned about the impacts of low interest rates on credit and asset price growth. Yet on the other, they wish to ensure financial stability which appears to be at odds with the current loose monetary stance. The case for higher rates based on price inflation or wage growth is weak. But there is an argument to suggest that the wider impacts of running a loose monetary policy require some tightening. For the moment, the likes of Norges Bank and the ECB can get away with merely talking about it. The BoE fiddles around the edges by adjusting macroprudential measures. But before long, they may all be forced to follow the Fed – everyone does in the end.