Investment Clock insights

Raising inflation targets is not an easy answer

Ian Kernohan

20 June 2017

With inflationary pressures still so low almost a decade after the Great Recession, thoughts have turned again to raising inflation targets, as a way of helping monetary policy give an extra push to the economy, allowing it to break out of its post crisis tram lines. If the US Federal Reserve had a higher inflation target today, so the argument goes, it would not be raising interest rates, happy to let the economy and markets roar away.  A step change in inflation expectations would cut real interest rates even further, adding further fuel to the fire: the hunt for yield would become a frenzy, as the real return on cash would fall even further, pushing investors into riskier assets.

The benefits of raising the higher inflation target would have to exceed the costs, and that is not clear to me, especially in UK.  If raised once, why not again? For the UK, with its long history of botched attempts at controlling inflation, hard won credibility would go out the window very quickly.  For all the criticism levelled at the independent Bank of England, inflation expectations in the UK are certainly lower and more stable than under previous monetary policy arrangements. Higher inflation would just end up squeezing real incomes, something we are seeing in the UK at the moment. Meanwhile in the eurozone, prudent Germany would oppose any move by the European Central Bank to tolerate higher inflation. 

The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. The views expressed are the author’s own and do not constitute investment advice.