Tags: paul krugman | draghi | europe | Central Bankers

Krugman Warns ECB Panel That World's Central Bankers Have It Wrong

Tuesday, 27 May 2014 08:57 AM

Paul Krugman thinks Mario Draghi’s biggest thinkers have got it all wrong.

Speaking to a gathering of the European Central Bank’s top researchers and policy makers, the Nobel Laureate said the ECB and other banks around the world need to raise the inflation targets they have clung to since the 1990s.

At 2 percent, those goals are too low and increase the risk that central banks will run out of room to cut interest rates — the so-called zero lower bound.

“The intense resistance of central bankers to regime change even after more than five years at the zero lower bound shows that the kind of policy stasis that afflicted Japan for almost two decades is a more or less universal phenomenon,” Krugman said in a paper delivered to Draghi and other officials in Sintra, Portugal.

Krugman’s critique, which says central banks should raise their target to, for example, 4 percent, is especially relevant for an institution currently grappling with the threat of a deflationary spiral that’s forcing ECB officials deeper and deeper into unconventional policy.

Inflation in the euro region is at 0.7 percent and Draghi said in a speech yesterday that officials need to be watchful in case a “negative spiral” in prices takes hold.

Krugman argued that too low an inflation target may be giving European policy makers an excuse not to do more, what he calls a “complacency trap.”

Blunt Talking

“As long as prices remain stable, some officials will argue that monetary policy is doing its job, that any remaining economic difficulties must be addressed with structural reform,” Krugman said.

“And let’s be blunt, there are already visible tendencies toward a similar loss of resolve in Europe, for example declarations by monetary officials that low inflation isn’t really a problem because it’s mainly driven by needed adjustments in debtor nations.”

Krugman’s comments weren’t welcomed by some.

Otmar Issing, who helped devise the ECB’s policy framework during his time as its chief economist, said raising the inflation target risks signaling that officials are becoming complacent about price growth.

“How to re-anchor inflation expectations?” Issing said. “It’s not a mechanical issue, it is a credibility issue and central banks will have a hard time to explain that.”

Election Fallout

Federal Reserve Bank of St. Louis President James Bullard backed Issing up.

“The whole point of inflation targeting is that this is something you can actually do as a central bank, and if you can’t hit it and you start setting other inflation targets, it’s not going to matter,” he said. “I think being able to hit the inflation target is very important.”

Krugman’s paper wasn’t his only intervention that poked at the gathered European Union elite. A critic of austerity as a tool to fix the euro crisis, he yesterday tore into a discussion by European Commission President Jose Barroso and Eurogroup President Jeroen Dijsselbloem about the results of Sunday’s European elections.

“Sitting in a room listening to EU officials reacting to the European Parliament elections — and it seems to me that they’re deep in denial,” he wrote in a New York Times blog.

“The possibility that things are so bad — and radicals have been empowered — because the policies are fundamentally misguided just doesn’t seem to be considered.”

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Paul Krugman thinks Mario Draghi's biggest thinkers have got it all wrong.Speaking to a gathering of the European Central Bank's top researchers and policy makers, the Nobel Laureate said the ECB and other banks around the world need to raise the inflation targets they have...
paul krugman, draghi, europe, Central Bankers
Tuesday, 27 May 2014 08:57 AM
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