Nobel awardee Kydland says CBs need to focus on managing inflation

Malaya News, February 8, 2008

CENTRAL banks should focus on keeping inflation conducive for growing business than making a direct effort to push economic growth cutting interest rates, a Nobel Prize awardee for economics said.

Prof. Finn Erling Kydland said cutting rates to save the financial market is not the duty of central banks, an obvious potshot at the Fed’s drastic rate adjustments, something that central banks around the world have the propensity to follow.

However, he said central banks can manage inflation, which is their contribution to the growth of companies.

"Central banks can't do much in affecting immediate earnings potential of businesses. Maybe they can do more than the usual by providing a low inflation environment,"

Kydland said in a dinner held in his honor by the Bangko Sentral ng Pilipinas in Makati Wednesday night.

Kydland expressed surprise at the frantic action of the Fed to lower rates ahead of schedule, in an obvious move to stop the stock market from further hemorrhaging.       

"It's inevitable that the Fed would cut rates but they could have waited at the right time. What business do central banks have in helping the stock market when they should focus on inflation?” the University of California (Santa Barbara) and Carnegie Mellon University economics professor said.”

Kydland said central banks, led by the Fed, had put too much emphasis on the subprime crisis, using the monetary policy to prevent a fallout instead of just sticking to their inflation goals.

Their “behavior,” Kydland said could “raise inflation expectations in the future. So other than alleviating subprime fears, the Fed, for instance, has become less “powerful in jumstarting the real economy.”

“What they said worry is that their decision could raise inflation fears, and that’s a valid concern,” the 2004 Nobel Laureate said.

There’s something, however, that central banks can do – to make banks continue to lend.

Because of the crisis, banks have become reluctant to lend, adopting a “cautious” stance, something that has an adverse impact on economies, he said.

“Banks become more cautious in lending to business. If central banks can do something to lessen that cautiousness then they contribute to making the subprime crisis less severe,” Kydland said.

Kydland warned that the rest of the world has not decoupled from what’s happening in the US and so countries, such as the ASEAN 5, should be ready to take a hit should the subprime crisis worsen.

“There’s a spillover effect from one country to the other parts. You can’t expect a block of countries to decouple from the rest of the world,” he said, stressing the technological links that make markets highly dependent on each other.