Central banking has undergone an evolution. Jay Powell, who as head of the US Federal Reserve is arguably the most important economic policymaker in the world, has said he will tolerate higher inflation to boost growth and jobs in the US. That marks a significant shift in the framework that has shaped central bankers’ decisions for decades – that of inflation targeting.
Under this framework central banks promise to hit a price goal – usually of 2 per cent – over the course of the years ahead, regardless of their earlier performance. Mr Powell has broken with tradition by saying the Fed will pay attention to previous misses, and aim to average out inflation at 2 per cent over the longer term.
This evolution was sorely needed. As central banks gained independence to set rates as they saw fit over the course of the 1990s, inflation targeting helped boost credibility and offered political cover by providing a clear framework through which technocrats would make decisions. The economic thinking behind it was that when central banks clearly communicated their intentions, businesses and individuals would adjust their expectations of what would happen to prices. This, in turn, would help spur investment and keep wages in check.