Are Central Banks At A Crossroads Or A Dead-end?

What about inflation as expected by professional forecasters and financial markets? Surveys of economists may be useful but they bear little relation to the wider population. Measures of expected inflation in financial markets matter to market prices and traders' P&L accounts, but fluctuate far too much to be reliable estimates of future inflation over the long term.

Why would an apparent estimate of inflation over the next 30 years fluctuate with spot moves in the oil price? Much of the shifts appear to be related to fluctuating risk premia, which central bankers thankfully acknowledge.

So where does this leave us and what is to be done?

Central banks need some fresh thinking and a new mindset. They must recognise their models are not working, try to understand why and revise them accordingly (something which should be happening anyway).

They must also recognise that a precise inflation target is misguided. Their goals should be more modest, but pursued more aggressively.

As a starter, I propose the following goals in order of emphasis: firstly, to promote financial stability and prevent collapses of the financial system; secondly, to promote low inflation as measured by a range of 1% to 3% over the medium term; and finally, to facilitate economic growth.

By far the most critical function of the central bank is its role as ‘lender of last resort'. Preventing economic catastrophes matters far more than tinkering with interest rates.

The other goals of maintaining low inflation and encouraging growth are valuable, but imprecise.

Alongside the revised mandate should come a change in mindset; do less more often, but be bold when required. Small changes in interest rates are usually irrelevant, but central banks should act much more boldly when they look like missing those wider targets.

For this, they need new and revised tools, as my colleague, Eric Lonergan has argued. More QE is not the right medicine, as the Japanese experience suggests.

Wider adoption of targeted lending (TLTROs) at dual interest rates, greater powers to buy equities and credit to reduce private sector risk premia during recessions and the capacity to make direct transfers to the private sector would, however, be game changers.

Central banks need a radical rethink, while conditions are good. More of the same is simply not good enough.

Tristan Hanson is manager of the M&G Global Target Return fund