© Reuters. FILE PHOTO: The President of the European Central Bank, Christine Lagarde, arrives for a welcome dinner at the Murabba Palace in Saudi Arabia during the G20 meeting of finance ministers and central bank governors
By Leika Kihara, Francesco Canepa and Howard Schneider
RIYADH / WASHINGTON (Reuters) – Central bankers from the United States, Japan and the Eurozone who met this weekend in the desert kingdom of Saudi Arabia had to overcome their own sand – that of elusive inflation.
The problem of all three is that price growth has long ceased to behave as expected, as aging populations and technological advances prevent inflation from reaching its estimated 2% target despite aggressive stimulus measures.
This is leading to a profound rethinking of the world's most powerful central banks, starting with defining their goal and the tools they use to achieve it – a process that has become more pressing than the world is preparing for the economic impact of the corona virus.
The meeting of financial leaders from the 20 leading economies in the world in Riyadh gave the Fed chairman Jerome Powell, ECB President Christine Lagarde and the Governor of the Bank of Japan Haruhiko Kuroda the opportunity to compare notes.
Lagarde was due to meet Powell later on Sunday after a brief exchange with Kuroda the previous day.
"All major central banks face similar problems, including how to deal with another economic downturn," said an executive at one of the banks attending the G20 meeting.
"You have been discussing this topic for a while. It is time to draw some kind of conclusion," he said on condition of anonymity due to the sensitivity of the matter.
Kuroda has many lessons to learn about the dangers of leaving subdued price growth unattended for too long. He used a strong dose of stimulus in 2013 only to see that inflation stagnated well below its 2% target.
Given such dangers, the Fed is in the middle of its framework review, which focuses on how to track 2% inflation using instruments such as forward guidelines.
In its own review, the ECB will almost certainly revise its inflation target, which is defined as a "below but close to 2%" rate of growth, to signal that it does not see this level as an upper limit.
Inflation can be economically and politically destructive if prices rise too quickly but a moderate pace like 2% is considered necessary for companies to increase wages and create a positive cycle for the economy.
Critics doubt that changes in the definition of price targets are effective to counter the headwind from demographic and technological innovations.
Older sections of the population tend to consume less, while new technologies promote greater efficiency at lower costs. Together, they can be powerful forces leaning against inflation.
To tackle this, the Fed has been testing ideas such as a "makeup strategy," according to which a central bank promises to push inflation above target to offset times of weak economic conditions.
But that would tie the hands of future policy makers – a risky strategy. "It works wonderfully in models," said Thomas Barkin, president of the Federal Reserve Bank of Richmond. "It makes me nervous in practice."
Many BOJ officials are also concerned about a further review of the framework and doubt that changing the inflation target will help people believe in price increases.
"Within the BOJ, there are doubts whether pledging to achieve higher inflation could dramatically change public perception, especially if inflation is still far from the current target," said a source familiar with her thinking.
With central banks having no clear breakthrough on other instruments, managing public expectations is one of their strongest weapons today.
Yet the rising costs of sustained low interest rates, from rising house prices to dwindling returns for pension funds mean that central banks cannot simply hope that inflation will one day accelerate.
"The side effects are now more acute and I think we should weaken our communications, while the benefits far outweigh the costs," said an ECB politician on condition of anonymity.
IMF executive director Kristalina Georgieva rejected the idea that interest rates could stay low forever, and compared policy-makers' complacency to a frog that doesn't notice it is swimming in the gradually heated water until it's too late ,
"This is the risk we face," she said at a conference on the sidelines of the G20 meeting this week. "That a gradual accumulation of debt in a low interest rate environment doesn't give us a good signal … to jump out of the boiling water."