For years leading central banks have focused almost single-mindedly on the control of inflation as the bedrock of economic prosperity. Whether they explicitly pursue an inflation target, as is the practice of the Bank of England, the Reserve Bank of Australia and many others, or implicitly do so, as in the case of the Federal Reserve and the European Central Bank, these institutions carefully monitor price and output trends and have developed elaborate models for setting interest rates, all with the paramount goal of achieving low and stable inflation. As Alan Greenspan testified to Congress in the early 1990s, “The most important contribution the Federal Reserve can make to encouraging the highest sustainable growth the U.S. economy can deliver over time is to provide a backdrop of reasonably stable prices, on average, for business and household decision making.”

In the wake of the financial crisis, however, central bankers are rethinking their goals. Price stability is no longer enough by itself. Indeed, many central bankers now acknowledge that low inflation, and the low interest rates that accompanied it, helped cause the crisis by encouraging banks and investors to take on ever-greater risks in the search for yield — a point many private economists have been making. “I’m on a mission to get people to recognize the important role that monetary policy has played in getting us into this mess,” says Stephen Roach, senior fellow at the Jackson Institute for Global Affairs at Yale University and a former chief economist at Morgan Stanley. The Federal Reserve’s mandate of promoting maximum employment and stable prices “doesn’t cut it when you have low levels of inflation,” he adds. “It biases you to excessively easy monetary policy.”

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