But I suspect that we may be even more willing to be ‘flexible’ inflation targeters now than we were in the late eighties and early nineties, when we were at the beginning of our inflation targeting experience.
These risks stem from government bonds held on bank balance sheets. And that is precisely where the problem needs to be tackled. Bank regulation treats government bonds comparatively generously. Usually, the higher the risk attached to a loan, the more capital a bank must hold against it. Yet this does not apply to lending to governments – and thus to government bonds.