Should central banks be revamping their monetary policy frameworks and liaising more with governments?

With the trade war threatening already slowing global growth, it could be time for central banks to synchronise their efforts more closely with government fiscal goals

While crossing the line separating government and central banks might be harder in advanced economies, China may be better placed to do so

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Yi Gang, governor of the People’s Bank of China, arrives for the European Union-China high-level economic dialogue at the Diaoyutai State Guesthouse in Beijing, China, on June 25, 2018. With its centrally planned economy, China could ensure closer integration between monetary policy and government objectives. Photo: Reuters

Published: 2:00pm, 13 May 2019Updated: 10:24pm, 13 May 2019

Central banks seem to have fallen asleep at the wheel again. At a time when the world economy needs better leadership, the global monetary authorities seem to be losing their edge. Global growth is underperforming and there’s been a chronic undershooting of inflation targets in recent years. Central banks could be losing control of sound monetary management. What should they really be targeting and is the world ready for change?

There’s clearly a need for a different approach, especially with the US-China trade war hitting new lows and the world economy potentially facing a fresh wave of uncertainty. The big dilemma is whether the 2 per cent inflation goal, the norm for many central banks, is truly up to the job or even relevant any more. In a post-deflationary environment, the worry is that monetary policy in America, Asia and Europe has been running too loose for too long as central banks have fallen short on inflation.

It means central banks are gambling with too-low rates, over-revving the world with excessive stimulus and ramping up asset markets like housing and stocks, while economic growth, prices and wages miss out. If the global economy has entered a grey zone of sub-par growth and muted inflation risk, then central banks stand little chance of normalising interest rates back to higher levels for the foreseeable future.

At least the US Federal Reserve is starting to think about alternatives for a new monetary framework for the future. How far it gets is another matter. There have been suggestions that the Fed’s 2 per cent consumer price index target should be abandoned in favour of a lower, more achievable goal. There have even been calls to introduce formulaic rules to make interest-rate decisions in a more mechanistic manner.

Instituting a more systematic rule-based procedure for setting monetary policy could be controversial, especially in times of crisis, when emergency needs to bolster the economy might pull in different directions. There are similar debates under way in other counties, too. In the UK, the British opposition Labour Party is considering changes to the Bank of England’s remit to include statutory house price controls to discourage needless overinvestment in the housing market.

Putting any sort of rule-based system into practice could prove a minefield for the central banks, especially when a 2 per cent inflation target is so easy to apply. Aided by forward policy guidance, central banks generally get what they want in terms of moulding interest-rate expectations, but the question remains whether they end up at the right level for effective demand management.