Inflation targeting in the West

An International Monetary Fund staff paper released on 12 February suggested that policymakers might consider raising their inflation target to 4% from 2% to allow monetary policy to be more effective in future deflationary crises.

The paper, “Rethinking Macroeconomic Policy”, said that the 2% target chosen by most central banks was sufficient ”in a world of small shocks.” But during the financial crisis of 2008, which triggered a broad collapse in aggregate demand, central banks could not effectively cut interest rates below zero, limiting the effectiveness of their monetary policy.

“Higher average inflation, and thus higher nominal interest rates to start with, would have made it impossible to cut interest rates more, thereby probably reducing the drop in output and the deterioration of fiscal positions,” wrote lead author Olivier Blanchard, the IMF’s research director.