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Sunday, 12 May 2019

Flexible monetary policy: a buffer against government debt?

Flexible monetary policy: A buffer against government debt? Central banks need to be flexible in their monetary policy, rather than dogmatically pursuing higher prices in the face of lower-than-expected levels of inflation, argues Marie Owens Thomsen, global head of investment intelligence at Indosuez Wealth Management, in the FT. While the 2% inflation target widely adopted by central banks worldwide has been effective in creating stability, recent low inflation has also been a driver of economic growth by increasing real wages and consumption, he argues. But low inflation masks another economic reality: government debt is at a high, and if a sudden increase in inflation were to occur, debt sustainability crises could follow.

Is fiscal and monetary policy coordination the key to success? Monetary policy needs therefore to be both flexible enough to combat such risks and well aligned with fiscal policy. Balance sheet interventions, including quantitative easing, credit easing, and emergency lending assistance, could be used for this purpose. They are effective tools for influencing aggregate demand, interest rates, and amounts of money and credit in order to affect overall economic performance. There is evidence that several major central banks are already employing these more flexible monetary policy tools, even though many maintain that shorter-term policy rates are preferred. The trend, however, is one to welcome. A degree of coordination between central banks and debt-management offices, institutions that traditionally work separately, would also be an effective way of utilizing expertise and offsetting risk, Thomsen argues.

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