MNI: Central Banks Should Revisit Hot Economy Frameworks - IMF

Central banks should revisit policy strategies that focus on running the economy hot given more palpable upside inflation risks, said International Monetary Fund First Deputy Managing Director Gita Gopinath.

"Policy strategies based on a flat Phillips curve, including 'running the economy hot' and 'looking through' temporary supply shocks, should be revisited," said Gopinath, the IMF's former chief economist, in a speech prepared for the Fed's annual Jackson Hole symposium. "While running the economy hot can indeed have important benefits, and is sometimes appropriate, we need to rethink the benefits and costs in light of the more evident inflation risks."

Gopinath's remarks come just two years after the Federal Reserve unveiled a new policy approach after an 18-month review that was aimed at beating weak inflation that had dogged central bankers for about a decade after the financial crisis. The Fed's 2020 shift toward an average inflation target largely recognized the central bank's persistent shortfalls from the 2% target and a desire to make up for them in the future but the framework has come under increased scrutiny as inflation hits 40-year highs.

Approaches that run the economy hot can produce considerable benefits, but policy makers must think about how to refine the strategies to better contain the risks they may pose to price stability, said Gopinath. The FOMC has said it intends to conduct a regular review of its monetary policy strategy, tools, and communication practices roughly every five years.

DEANCHORING RISKS

The IMF official also sounded alarms that inflation expectations could become deanchored. "With inflation running at multi-decade highs and some measures of inflation expectations flashing red, the risks of de-anchoring are significant," she said, urging central banks to get inflation back to target.

Fed economists and outside advisors recently told MNI that some easing in inflation expectations in recent weeks has provided little comfort since the moves have been primarily due to a fall in gas prices that may still prove volatile.