Monetary policy that targets inflation has failed to create a more stable macroeconomic environment, says AllianceBernstein (AB).
In an economic update, AB US economist and director Joseph Carson said inflation targeting has failed to achieve economic stability because the monetary policy framework is flawed.
“Success for this type of monetary policy framework depends as much on selecting the appropriate basket as it does on the specific price target,” he said.
Mr Carson said that in the US, policymakers selected consumer price index (CPI) as the appropriate basket of items. However, the structure of CPI does not include housing.
This inflation-targeting framework is flawed, he said, because housing, more than any other product, is highly influenced by the cost of borrowing and liquidity conditions.
“Also, the acquisition of housing involves the accumulation of debt. Consequently, by not formally monitoring prices and credit use, policymakers run the risk of creating macro imbalances in the economy that could become systemic,” Mr Carson said.
While the price target of inflation is important, it is not as important as the specification of the price measure, he added.
Central banks can influence the cost of borrowing but they cannot direct liquidity flows. It is only the private sector that can dictate flows, he said.
“Formal price targeting can only work well if policymakers focus on actual prices and include prices that are most sensitive to monetary policy changes," said Mr Carson.
“Any attempt to add more monetary stimulus to the system, with the simple goal of trying to achieve a narrow price target, is likely to result in even greater price imbalances and potentially more economic instability."
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