Should central bankers fight inflation or go for growth?

Since 1998, the European Central Bank's priority has been to maintain price stability in the euro area. However, EU-funded researchers have proposed that central bankers should place more emphasis on boosting the economy in difficult times. The project's recommendations could feed into policies for a more prosperous Europe.

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Countries
Countries
  Algeria
  Argentina
  Australia
  Austria
  Bangladesh
  Belarus
  Belgium
  Benin
  Bolivia
  Bosnia and Herzegovina
  Brazil
  Bulgaria
  Burkina Faso
  Cambodia
  Cameroon
  Canada
  Cape Verde
  Chile
  China
  Colombia
  Costa Rica
  Croatia
  Cyprus
  Czechia
  Denmark
  Ecuador
  Egypt
  Estonia
  Ethiopia
  Faroe Islands
  Finland
  France
  French Polynesia
  Georgia


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Published: 29 July 2019  
Related theme(s) and subtheme(s)
Pure sciences
Research policySeventh Framework Programme
Science & business
Science in society
Social sciences and humanities
Countries involved in the project described in the article
Spain
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Should central bankers fight inflation or go for growth?

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© anyaberkut #180953964, source: stock.adobe.com 2019

Central bankers face the age-old dilemma: whether to use their powers over a currency to guard against inflation or boost the economy. Since its creation in 1998, the European Central Bank – the institution that administers monetary policies in the euro area – has favoured maintaining price stability. But is this the right strategy?

To help resolve the dilemma, the EU-funded MONFISCPOL project set out to develop economic models for the design of fiscal and monetary policies to tackle economic crises. The project’s researchers concluded that European central bankers should rethink their priorities and adopt a so-called ‘dual mandate’ – an approach whereby bankers give concerns about economic growth as much weight in their decision-making as fears about inflation.

‘One result of the project is that if central banks were to adopt policies consistent with a dual mandate, there would be a sizeable reduction – at least 50 % – in welfare losses due to economic fluctuations,’ says Davide Debortoli, MONFISCPOL’s project coordinator and associate professor at the Universitat Pompeu Fabra in Barcelona, Spain.

Balanced approach

Academic economists typically build models based on their research which they then use to test different scenarios. For example, they might explore what happens to the economy if a recession begins while central bankers are trying to combat inflation.

By contrast, MONFISCPOL researchers used a model similar to that actually employed by policymakers inside central banks to make predictions and craft policies. That model was their laboratory to see what happens when central bankers give more weight to some policy options than to others.

According to Debortoli, one finding was that economists typically believe that central bankers should give a mere 5 % ‘weight’ in their decision-making to boosting the economy, with the other 95 % going to fighting inflation.

However, MONFISCPOL researchers found that, within the models that central bankers use, the weights should be half and half: 50 % for inflation and 50 % for growth.

The project’s research also led to the conclusion that ‘credible’ central banks that consistently honour their policy objectives are more likely to contribute to economic growth.

Finally, MONFISCPOL studied how governments structure their long-term debt holdings. Researchers argued for the use of perpetual bonds with no maturity dates – also known as ‘consols’ – as tools for managing government debt.

Damage limitation

The project ended in June 2017, and Debortoli cautions that the project’s results are not an excuse for politicians to print money irresponsibly. ‘Our study… should not be used as a justification for limiting central bank independence from political power,’ he says.

He adds that a dual mandate would work in response to a ‘stagflation’ shock to the economy when sudden price rises cause both inflation and recession simultaneously. But a dual mandate only works if ‘the central bank has a solid reputation to keep long-term inflation expectations anchored. Such a reputation, however, is strongly related to a central bank’s independence from political pressures.’

Project researchers published articles in three top scientific journals: the Quarterly Journal of Economics, the Economic Journal, and the American Economic Journal, Macroeconomics. They made more than 40 presentations at international conferences around the world at venues such as the US Federal Reserve Board of Governors, the European Central Bank, and the International Monetary Fund.

The project also organised two workshops on their results in Barcelona in June 2016 and June 2017.

Project details

  • Project acronym: Monfiscpol
  • Participants: Spain (Coordinator)
  • Project N°: 628855
  • Total costs: € 230 036
  • EU contribution: € 230 036
  • Duration: July 2015 to June 2017

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