What next for Central Banks?

Three weeks ago, I highlighted that central banks across the globe may be forced to keep rates higher for longer given the secondary risks to inflation arising from higher wages and embedded inflation expectations. At the time, I was thinking about what this might mean for growth. However, as these risks become more pronounced, an arguably more important factor to consider is what will happen if central banks choose to become more tolerant towards higher prices. Rather than keeping rates higher for longer, or even tightening policy further to bring inflation down to the 2% target rate most central banks have adopted in recent years, what would happen if they decided to accept higher inflation and shift their target rate to 3-4% instead?

Addressing the issue in the FT, former Bank of England Chief Economist, Andy Haldane, called for central banks to adopt a more flexible approach. Higher prices, he explained, are a result of dislocations in global supply chains, buffeted by geopolitical crosswinds. The end of the golden age of globalisation, and the fact that it will take a long time for supply chains to be repaired, mean that the traditional approach to dealing with inflation will not have the desired effect this time around.

In his opinion, sticking with rigid inflation targets will either result in them being continuously missed (assuming the central banks do not tighten enough) or it will unnecessarily damage any green shoots of growth (if they continue to raise rates). Instead, he proposes a more flexible approach involving either transparently lengthening the horizon upon which inflation will be expected to return to target or, more radically, temporarily suspending the target all together and pledging to reinstate it at the earliest possible future date.