Concern about sluggish growth and poor productivity is now high on the political agenda across the developed world. Yet the debates around the UK Budget and the US presidential election have failed to touch on one of the most important factors behind this trend, namely a monetary policy over-focused on near-term inflation targets and too little concerned with developments in credit and debt markets.
The widespread adoption of 2 per cent inflation targets has been, at best, a mixed blessing. For a start, equating 2 per cent inflation with price stability — a nebulous concept — is highly questionable. Such a target prevents a natural downward adjustment of prices after increases in productivity or positive supply shocks. If price rises are not allowed to go below 2 per cent, there will be an inbuilt bias towards inflation and against long-run price stability.