IMF questions inflation targeting for rates

The International Monetary Fund has reignited debate about whether inflation targeting is the best way for central banks to set interest rates.

Currently, stable and low inflation is the primary target of central banks.

Australia's Reserve Bank, for example, aims to keep inflation within a 2 to 3 per cent target band, and it uses interest rates to boost or slow down the economy when it looks like inflation will get too far out of that range.

However, according to the IMF's chief economist, Olivier Blanchard, inflation targeting should not be the only tool, and he says stable inflation might not be sufficient, and that low inflation actually lulled many economies into a false sense of security in the lead up to the global crisis.

Notably, he refers to the dangers of falling into a liquidity trap - or easy access to money - which sparked the subprime mortgage crisis.

The IMF is arguing that, in some cases, a 4 per cent inflation limit should be allowed.

Another idea is that lowering interest rates to stimulate the economy in a scenario of rising unemployment may not be the best approach, and that cash handouts or stimulus payments might be a more direct solution.

There is also discussion of perhaps going more directly to banks which caused the crisis in many ways, with tighter regulation to prevent the problems of a few spreading to entire economies.

This discussion is particularly relevant in Australia, as there is already a big debate about the link between government spending and higher interest rates.

We will find out more this week when the Reserve Bank governor Glenn Stevens faces the House Economics Committee on Friday, when it is also likely that Mr Stevens will be asked for his views on the need to cut government debt and to reduce government spending.


(Source: acb.net.au, By business editor Peter Ryan for AM)