TOKYO (MNI) – U.S. Federal Reserve Chairman Ben Bernanke said on
Wednesday that major nations should stay with a well established notion
of guiding the annual inflation rate to around 2%, instead of targeting
a higher inflation rate in hopes of securing a wider safety margin for
cutting interest rates to a non-inflationary level during economic
slumps.

Most studies have argued that the optimum annual inflation rate
should be fairly low, around 2%, assuming that the world is pursuing it
from scratch, he told an international conference at the BOJ on the
future of central banking in a globalized world.

But central banks around the world are not starting from scratch on
this issue and “for over many years now have established a great deal of
credibility for inflation rates in the vicinity of 2%,” said
Bernanke.

“It’d be a very risky transition if we in any way reduced our
commitment to a 2% approximate inflation target,” he said, in response
to a question as to whether countries should go for a higher inflation
rate.

“We are not sure how expectations would react. It could be that 4%
would not be stable … people would expect even a higher inflation rate
after that.”

“Given the investment central banks have made in creating very
strong expectations of price stability, we are better off staying
essentially where we are,” said the Fed chairman.

Despite increases in inflation rates a few years ago, in the U.S.
inflation expectations “have been remarkably stable,” which in turn
helps stabilize inflation itself, he said.

In opening remarks at the conference, BOJ Governor Masaaki
Shirakawa warned against targeting a higher inflation rate for the sake
of generating a larger buffer against a spike in consumer prices when
slashing borrowing costs in economic and financial crises.

In a deep and far-flung crisis like the current one the world
faces, lowering interest rates a little more would not cure a sharp
plunge in global demand, he added.

Before the current global financial crisis, Shirakawa said, “a
safety margin against the zero lower bound of nominal interest rates was
often pointed out as one of the justifications for targeting a small but
positive rate of inflation.”

“In the end, major countries found themselves virtually constrained
by the zero lower bound under the current crisis,” he said.

“Looking back at the serious economic downturn after the failure of
Lehman Brothers, very few think that reducing interest rates by a few
percentage points, enabled by having a higher target rate of inflation,
would have materially changed the recovery path of the economy.”

Shirakawa noted while price stability itself is desirable, “it
entails a complex mechanism for destabilizing the financial system, if
combined with over-confidence in economic agents and unfounded
expectations about the prolonged low interest rates.”

Different central banks have different ways of seeking price
stability but it is possible to present some clarity on what they are
trying to achieve, said Bernanke.

The BOJ has a loose inflation guidance about what its policy board
believe should be a desirable CPI rate in the longer term, currently
around 1%, in a range of somewhere above zero and under 2%.

While the Fed does not have an explicit inflation target, its
policymakers communicate their individual ideas about where prices
should settle in the longer term. The Bank of England and the Bank of
Canada have clear inflation targeting mechanisms.

Asked about dollar swap deals for funding global markets that have
been resumed this month among major central banks in light of the Greek
debt crisis, Bernanke replied that they should be used only in
emergencies and not as a permanent service to financial markets.

“There is a good case that we should put pressure on, or at least
try to influence, banks to better manage these currency mismatches,” he
said.

For his part, Shirakawa said information gained from a network of
central banks is important when providing liquidity via currency swaps,
and that “we should make various efforts on various fronts to make
currency funding markets more stable.”

tokyo@marketnews.com
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