IMF inflation target could boost stock prices!

Inflation Target 4% - IMF -

IMF economists, Giovanni Dell'Ariccia, Paolo Mauro and Blanchard says policy makers need to consider radically different approaches to deal with major banking crises, pandemics or terrorist attacks. In particular, the IMF paper suggests shooting for a higher-level inflation in "normal time in order to increase the room for monetary policy to react to such shocks." Central banks may want to target 4% inflation, rather than the 2% target that most central banks now try to achieve, the IMF paper says.

At a 4% inflation rate, Mr. Blanchard says, short-term interest rates in placid economies likely would be around 6% to 7%, giving central bankers far more room to cut rates before they get near zero, after which it is nearly impossible to cut short-term rates further.

"Now we realize that if we had a few hundred extra basis points"—a basis point is one-hundredth of a percentage point—"to rely on, that would have helped" fight the recent downturn, Mr. Blanchard says. "So it would have been good to start with a higher nominal rate. The only way to get there is higher inflation."

John Taylor, a Stanford University monetary-policy specialist who served in the Bush administration Treasury department, says that inflation could become hard to constrain if the target is raised. "If you say it's 4%, why not 5% or 6%?" Mr. Taylor said. "There's something that people understand about zero inflation."

The new paper, titled "Rethinking Macroeconomic Policy" also recommends that central banks use regulatory weaponry try to prick asset bubbles before they grow dangerously large. Relying exclusively on raising interest rates to do such work risks damage to the broader economy, an argument that Federal Reserve Chairman Ben Bernanke has made.

"If leverage appears excessive, regulatory capital ratios can be increased," the paper says. "To dampen housing prices, loan-to-value ratios can be decreased; to limit stock price increases, margin requirements can be increased."Mr. Blanchard says.

Source:IMF, WSJ, OBR

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