Macro’s dirty little secret

Originally published July 30

A dirty little secret of macro is that central bankers have come to realize that they cannot necessarily hit their inflation targets even over the longer term. Under the right conditions, they should be able to deliver on the price side of their mandate. But the idea that they can do so in all contexts simply as a matter ofprinciple has recently been discredited, with effects that are both important and under-appreciated.

What I am calling here a secret is actually a fairly open one. Central bankers, their advisors and their many watchers will now generally concede the point, if pressed and away from the spotlight. But this recognition is not yet emphasized in official communication or even properly embedded in the central banks’ macro models, so far as I understand. Nor is it well internalized in discussions about central banks.

And yet it is key to understanding the current monetary policy debate. It is arguably the main factor driving dovish turns at the ECB and Fed that might otherwise be hard to explain. The leaderships are now particularly eager to take advantage of high employment and relatively-serene economic conditions to push inflation higher in order to raise inflation expectations to a level consistent with their mandates.