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Kenneth Rogoff: The 4% non-solution

Kenneth Rogoff 

Kenneth Rogoff

For some time now, there has been concern that central bankers have "run out of bullets". Having lowered their to near zero, they have engaged in increasingly extravagant measures such as "quantitative easing" and "forward guidance". Given the fog cast over real economic activity by the financial crisis, it is difficult to offer a definitive assessment of just how well or badly those measures have worked. But it is clear that there must be a better way to do things.

There is no longer any reason to let the on nominal interest rates continue to hamper monetary policy. A simple and elegant solution is to phase in a switchover to a fully electronic currency, where paying interest, positive or negative, requires only the push of a button. And with paper money - particularly large-denomination notes - arguably doing more harm than good, currency modernisation is long overdue. Using an electronic currency, could continue to stabilise inflation exactly as they do now. (Citigroup's chief economist, Willem Buiter, has suggested numerous ways to address the constraint of paper currency, but eliminating it is the easiest.)

A second, less elegant idea is to have simply raise their target inflation rates from today's norm of two per cent to a higher but still moderate level of four per cent. The idea of permanently raising inflation targets to four per cent was first proposed in an interesting and insightful paper led by the International Monetary Fund's chief economist, Olivier Blanchard, and has been endorsed by a number of other academics, including, most recently, Unfortunately, the problem of making a smooth and convincing transition to the new target is perhaps insurmountable.

When Mr Blanchard first proposed his idea, I was intrigued but sceptical. Mind you, two years previously, at the outset of the financial crisis, I suggested raising inflation to four per cent or more for a period of a few years to deflate the debt overhang and accelerate wage adjustment. But there is a world of difference between temporarily raising inflation to address a crisis and unhinging long-term expectations.

After two decades of telling the public that two per cent inflation is nirvana, central bankers would baffle people were they to announce that they had changed their minds - and not in some minor way, but completely. Just recall the market's "taper tantrums" in May 2013, when then-Fed Chairman suggested a far more modest turn in monetary policy. People might well ask why, if central bankers can change their long-term target from two to four per cent, they could not later decide that it should be five or six per cent?


Given the likelihood of a confused, mistrustful public, it is hard to find any deep rationale for a four per cent target. At least the existing two per cent inflation target stands for something, because central bankers can portray it as the moral equivalent of zero. (Most experts believe that a true welfare-based price index would show significantly lower inflation than government inflation statistics indicate, because official data fail to capture the benefits of the constant flow of new goods into the economy.)

There is an analogy to the problems countries faced when they tried to re-establish the after Until the war, money was backed by gold and could be redeemed at a fixed rate. Though the system was highly vulnerable to and there was little scope for a policy, people's confidence in the system enabled it to anchor expectations.

Unfortunately, the system completely collapsed after the war broke out in August 1914. Revenue-desperate combatants were forced to turn to inflation finance. They could not simultaneously debase the currency and back it with gold at a fixed rate.

After the war, as things settled down, governments tried to return to gold, partly as a symbol of a return to normalcy. But the revived inter-war ultimately fell apart, in no small part because it was impossible to rebuild public trust. A move by to a long-term four per cent inflation target risks triggering the same dynamic.

Fortunately, there is a much better way. Moving to an electronic government currency would not require a destabilising change in the inflation target. Minor technical issues could easily be ironed out. For example, ordinary citizens could be allowed zero-interest-transactions balances (up to a limit). Presumably, nominal interest rates would move into negative territory only in response to a deep deflationary crisis.

But when such a crisis does occur, central banks could power out of it far more quickly than is possible today. And, as I have argued elsewhere, governments have long been penny-wise and pound-foolish to provide large-denomination notes, given that a large share is used in the underground economy and to finance illegal activities. Moving to a 21st-century currency system would make it far simpler to move to a 21st-century central banking regime as well.



The writer is professor of economics and public policy at Harvard University.

Copyright: Project Syndicate, 2014

First Published: Thu, June 19 2014. 21:44 IST
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