The chief economist of the Bank for International Settlements (BIS), Claudio Borio, has pleaded in a speech for a realignment of the policy frameworks of central banks. According to Borio, the inflation rate was the compass of previous monetary policy of the major central banks. Faced with structural factors, such as globalisation and technical progress, the needle of this compass is broken. It is therefore wrong to assume that the central banks could achieve their inflation targets, despite an expansionary monetary policy of historical proportions and robust economic activity. Continued attempts to achieve this could be accompanied by severe „collateral damage“ for financial stability. Rather than focus one-sidedly on inflation, central banks should adjust their policy frameworks to the new reality and attach less significance to the development of inflation and instead concentrate more on financial stability.
There is nothing new about the BIS’s pleas for greater weight to be ascribed to financial stability in central bank policy, but it makes sense. The Economic Policy Symposium in Jackson Hole already discussed the notion of regulation as a fine-tuning instrument for central banks – as a „scalpel“, unlike the instrument of interest rate policy that is wielded with wider effect. Borio’s hypothesis continues this discussion. It is clearly intended to be provocative – a provocation for those central banks which, like the European Central Bank, are adhering to their expansionary monetary policies for longer than necessary at the expense of mounting imbalances on asset markets.
The lead being taken by Borios‘ hypothesis should be viewed as the long-overdue onset of a discussion that I believe should be intensified in the coming months. Given the structural shifts in the factors that determine inflation, it is important more than ever before that contemporary monetary policy also monitors the risks and side-effects of an expansionary monetary policy and reconsiders its objective function.