Central banks are still missing their inflation targets

Big gaps persist despite years of monetary policy easing

Caroline Grady    

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As the world’s largest central banks resume asset purchases, the debate over the effectiveness of monetary easing rumbles on. One reason: policymakers have failed to close big gaps between average inflation and their targets.

The European Central Bank is just days away from renewing its bond-buying programme — and this time with no stated end-date. Meanwhile, the US Federal Reserve has returned to a schedule of Treasury purchases to prevent a repeat of the September liquidity squeeze in the repo market.

Investors are even weighing up the possibility of Australia adopting quantitative easing. Its policy rate stands at 0.75 per cent after three interest rate cuts in recent months, leaving little room for further easing. And the Reserve Bank of Australia has acknowledged that unconventional measures “would need to be on the table” if the economy were to take a really big hit.

However, one similarity between Australia’s central bank and its QE peers is the persistent miss on inflation mandates. Australia’s average 2 per cent inflation over the past decade falls short of its 2.5 per cent target.

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The extent of the inflation shortfall across the world has parallels with the size of balance sheet expansion. Switzerland has the largest inflation gap over the past decade at 2 percentage points. Japan has not fared much better. Both central banks now have assets in excess of national output, far above other major central banks.

The eurozone inflation gap is smaller at 0.7 percentage points and the balance sheet expansion more moderate. The ECB’s balance sheet is equivalent to 40 per cent of the bloc’s gross domestic product, a proportion that has doubled since quantitative easing was launched in 2015.

Christine Lagarde, the incoming ECB president, will have to navigate this new landscape while finding consensus within a divided governing council. With eurozone inflation dropping close to a three-year low, analysts expect bond purchases could run for several years yet.

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