The recent work by Rogoff and Reinhart suggests this would mean making sure that the 90% debt to GDP ratio is not reached, even after a plausibly serious stress scenario.4 Seen in this light, we may doubt that the 60% debt to GDP ratio that has been the reference since the Maastricht Treaty is sufficiently prudent. Let us now turn to the case of household indebtedness. Here the intermediating factor has been, in most recent examples, the burst of a housing bubble leaving, in particular, the most recent generation of buyers with a mortgage exceeding the value of their houses – that is, with negative equity. Besides system design failures which include policies that portray home ownership as a goal to be reached by everyone (President Clinton declared in 1994, “More Americans should own their own houses!”) and that are encouraged by public sector institutions, behavioural biases can be blamed as the main drivers of indebtedness.5 I could mention, first, a form of herding which is the simplest explanatory factor for an asset price bubble and, second, a “keeping up with the Joneses” effect, which is a plausible reason for the very low American savings rate and which Rajan, among others, uses as a potential link between the rise of inequality and increased indebtedness.
It lowers the real interest rate and contributes towards further increasing demand. When confidence in the inflation target is weak and inflation expectations are not well anchored, the result thus becomes larger fluctuations in the economy. We went through such a development in Sweden in the 1970s and 1980s, when the fixed exchange rate did not act as a sufficiently strong nominal anchor, which in turn resulted in recurrent cost crises and devaluations. The reason that debaters do not address the problems of abandoning the inflation target could, of course, be that they consider that the process of inflation has changed so much that central banks simply no longer can reach their inflation targets. This seems after all to be quite a common view in the debate. This would imply that it is not meaningful to set up targets for inflation, as it is determined by factors outside monetary policy. However, this is an assumption that, were it correct, would actually turn much of what is considered accepted within economic science on its head. Economic paradigms do change every now and again, of course. But, at a minimum, one may argue that quite a heavy burden of proof lies on those claiming it is no longer possible to choose an inflation target. Among other things, they would have to disprove Milton Friedman’s thesis that inflation is basically a monetary phenomenon. 17 Having said this, in practice, it is probably more of a gradual scale than a binary zero-one solution.