Is Price Stability Enough?
Very rarely do I come across an economic reading that is worth delving into. As a value investor, my economic realm tends to be micro- rather than macro oriented. But a recent paper is worth thinking about.
Resourceinvestor.com highlighted this interesting paper, entitled "Is Price Stability Enough?" The article is written by William White, an economist at the Bank for International Settlements.
Being old enough to have seen WIN buttons (Whip Inflation Now) and having presided over the asset-liability matching for an annuity driven life insurance company in the late 70's and early 80's, I embraced the plan of Paul Volcker to stymy inflationary thinking. As a portfolio manager in the 80's and 90's I embraced the notion of disinflationary stocks completely, as well as rode the bond market's rally or yield collapse. Drummed into most of us in that era was a resolve to believe that economic growth and economic policy that embraced disinflation was tightly correlated. Watching the economic experience of Japan through the 90's reminded us that deflation was an even more difficult issue to overcome...even zero real rates would not be stimulative when the country was awash with capacity.
In this paper, White suggests that pursuit of price stability might have to be applied more flexibly and with a longer-run focus than has been the case for most central banks.
Having price stability as the hallmark of central bank policy is no guarantee of growth. White notes that "A preceding period of price stability is not sufficient to avoid serious macroeconomic downturns." Extreme events (such as the Japanese collapse of the 90's, the emerging market crisis for Eastern Asia in 1997 and 1998 and the Great Depression) were preceded by credit-fuelled investment booms that occured during an era of stable inflation.
White argues that "a combination of technological change and deregulation has led to a quickening process of disintermediation from banks, growing reliance on market processes, globalization and institutional consoldidation. In short, we now have a liberalized system which seems much more likely to show boom-bust characteristics than the previously repressed one."
He warns, "The longer the period of macroeconomic stability, the greater the underlying excesses in investment and borrowing are likely to become."
A corollary of inflation targetting in a relatively benign environment is to encourage excessive debt accumulation.
What should policy emphasize? Identify the serious imbalances first. Develop incentives to encourage monetary policymakers to respond. Why? Overextended corporate and household balance sheets can also be the source of significant “headwinds”, reducing economic growth to levels well below potential. As far as the providing incentives to policymakers to respond, they should express publicly their intention to respond to emerging financial imbalances even if, occasionally, this leads to an undershooting of near-term
Bottom line, a little inflation may be a far better thing to contend with over the short term than the repercussions of the economic imbalances.
Overall, I think this is a worthwhile paper to contemplate this weekend from your lounge chair.
Have a good weekend!