Saturday, November 1, 2014

Deflation fears and central bank creditability

The post-80's period of central banking was all about creating creditability as inflation fighters and breaking inflation expectations. Central banks were only able to tame inflation when they were able to convince investors that they they could control inflation at set targets. The wave of inflation targeting and central bank transparency was all an effort to increase creditability. Central banks were successful at changing expectations and inflation was maintained close to target levels. It was expected that higher inflation would be met by tighter policies and targets would be maintained. Even the Fed which has a dual mandate was able to increase their creditability substantially as inflation fighters. The taming of expectations was won. 

Central banks may have done too good a job. Now central banks want to be known as deflation fighters who can raise inflation and hit targets from below. This adjustment in their creditability to inflation creators has been slow. Inflation expectations over the long-run have been close to targets but there has been a wariness that central banks do not have the tools or resolve to rid economies of deflation fears. The forward guidance has been ambiguous concurring their resolve to get inflation higher by the Fed. The resolve is also being questioned in Europe regardless of comments by the ECB president.

Perhaps the announcement by the BOJ to following QE will do the trick. The market reaction on Friday seems to be tiled to the belief that the BOJ has turned the corner and is willing to go to extraordinary length to get inflation higher. 

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