An odd argument by Andrew Haldane.

Haldane (chief economist at the Bank of England) put the following argument in a speech a few days ago.

Interest rates have been declining steadily for the last thirty years or so.

That means interest rates are now so close to zero that central banks have little room for manoeuvre when they want to impart stimulus. That is, CBs can’t cut interest rates much because they are already close to the so called “Zero Lower Bound”.

Haldane has two possible solutions, the first of which (his p.6) is to raise the target rate of inflation from 2% to 4%. That allegedly means CBs have an extra 2% of wriggle room: i.e. they can implement negative REAL interest rates more easily.

Now there’s a whapping great elephant in the room there, namely: how do you get to that 4% rate of inflation given that cutting interest rates is unlikely to do the trick? Well the answer has to be fiscal policy: i.e. government borrows £X, spends £X and gives £X of bonds to lenders. The CB may then do some QE and buy back some or all of those bonds.

Now if that fiscal stimulus works, what then is the point of the extra 2% inflation? Fiscal stimulus has solved the problem that interest rate cuts are unable to solve.

That being the case, why not just abandon the whole 4% inflation target idea and rely (or rely largely) on fiscal policy when stimulus is needed?

There could be an excuse for the 4% inflation target if interest rate adjustments were a much quicker or more sensitive way of adjusting demand than fiscal stimulus. But I know of no evidence to that effect: the evidence I’ve seen suggests that monetary and fiscal stimulus work at about the same speed.

And finally a warning: I haven’t been thru Haldane’s article with a toothcomb. If you want something more accurate than my above summary, read Haldane’s speech.