All else equal, we probably need to see not just stable prices of commodities and other tradable goods if we’re to meet the target over a reasonable horizon, but some further acceleration in domestic costs as well. While that’s what the central forecast in the February Inflation Report entails, the MPC will obviously have to be watchful, in the meantime, for signs that “good” deflation is turning into something worse. But we should not over-state the risks. The costs of deflation: income and interest rates matter too Something one hears quite often is that deflation is a problem “because it encourages people to postpone consumption”. Deflation – or more precisely the expectation that prices will fall – therefore weakens demand, it is said, and this can lead to a vicious circle in which prices are then depressed further. As far as it goes this has some truth to it. But it’s at best a partial description of the problem, at worst a bit misleading. It leaves out two important considerations. One is nominal income. Suppose you’re told that prices will fall over the next year but that the value of your income will remain unchanged. All else equal, the prospect of falling prices will give you an incentive to save more of your income (i.e. to postpone a bit of consumption). At the same time, the real value of that income will prospectively have risen.
It is an institution, it is said, which has lost its way. What is the truth of these allegations? Certainly, the Fund’s remit is unclear. Its lending activities have waned, and its role in the international monetary system is obscure. The tasks given to it by the conferences at Bretton Woods in 1944 and Savannah in 1946 need to be adapted to the financial circumstances of the 21st century. That was attempted in 1976 with the Second Amendment to the Fund Articles. But 30 years later it is evident that there is still more to do. We have an opportunity to return to first principles and ask some basic questions. Do we need an IMF? Is there a role for a multilateral institution in the management of the international monetary system? If so, what is it? Not before time are those questions now being asked in the corridors, if not the main floor, of international meetings which rotate endlessly around the world from one windowless room to another. Belatedly, the G-7 has started to discuss the future role of the Fund, and the IMF has initiated its own strategic review. Last October, the ministers and governors of the G-20 countries said that “more work is needed to develop a ‘roadmap’ for the future strategic reform of the Bretton Woods institutions”. And speeches by several G-7 ministers and governors, and as recently as ten days ago from the Managing Director himself, show that the debate on the role of the IMF is live.