* Fed Chairman Bernanke wary of higher inflation target
* Bini Smaghi: Hiking target would be "diabolical" error
* ECB's Weber says hiking target would open Pandora's box
* Wrong to think stimulus alone can revive global economy
By Francesca Landini
PAVIA, Italy, Feb 24 Raising inflation targets
as part of the monetary policy pursued by central banks would
be a "diabolical" error, European Central Bank Executive Board
member Lorenzo Bini Smaghi said on Wednesday.
U.S. Federal Reserve Chairman Ben Bernanke said the idea of
aiming for a higher inflation target, spelled out in an
International Monetary Fund research paper, made some sense,
but he worried it would be tricky to control.
"I understand the argument, and it's not without its
appeal, but it carries certain risks, obviously," Bernanke said
in testimony before a congressional committee. "If the Federal
Reserve says we're going to raise inflation to 4 percent, how
do we know that later it won't go to 5 or 6 or 7?"
Axel Weber, who heads the German Bundesbank and sits with
Bini Smaghi on the ECB's rate-setting Governing Council, said
the proposal was playing with fire.
In a speech at the University of Pavia in Italy, Bini
Smaghi said it was wrong to think the global economy could exit
the financial crisis and return to sustainable growth simply
through stimulus measures.
Instead, policy-makers need to throw out the solutions of
the past and rethink their whole approach, taking into account
that markets do not always price assets in an efficient way and
assuming lower economic growth than in the past.
A DANGEROUS IDEA
Some economists who still believed in the power of monetary
and fiscal policy had even suggested that central banks should
aim for higher inflation rates to create more room to move with
rate cuts when crises hit.
"It's as if to say that the main problem with monetary
policy in the recent past was that the so-called Greenspan put
had not been potent enough to avoid the negative consequences
of the bursting of the bubble, rather than being a mistaken
policy which fuelled the bubble in the first place," Bini
Smaghi said, referring to easy policy under former U.S. Federal
Reserve Chairman Alan Greenspan.
"The suggestion to raise the inflation target is
diabolical," Bini Smaghi told journalists after the speech.
IMF economists said in a research paper this month that
policy-makers might consider raising the 2 percent inflation
target chosen by many central banks to 4 percent.
The study is a dangerous proposal, Axel Weber said, in
comments which chimed with Bini Smaghi.
"The IMF is playing with fire," Weber wrote in a guest
column in the German daily Financial Times Deutschland, to be
published on Thursday, but made available to news agencies on
Higher inflation would harm more than benefit, he said, and
added the proposal risked endangering the credibility of
central banks as guardians of price stability and could open a
The ECB aims to keep inflation below but close to 2
percent, and in the past, it has resisted suggestions that it
change its price stability goal.
For U.S. Federal Reserve officials, the risk that inflation
expectations might drift outside their presumed comfort zone of
around 2 percent is particularly worrisome now.
The U.S. economy went through a bout of high inflation in
2008, when oil prices soared to record highs, followed by a
deflation scare in 2009 when the recession intensified.
Bini Smaghi also played down the risk of other countries
catching the Greek disease, saying there is no risk of
contagion as long as Athens carries out measures it has
WASTE OF TIME
Bini Smaghi also said the euro zone needs low interest
rates for now, but the ECB cannot commit to keeping them low in
the future and will base its decisions on economic conditions.
He said policies pursued before the crisis were aimed at
maintaining excessive rates of economic growth and developed
economies had not realized globalisation could bring slow
growth, a lower standard of living and more inequality.
"If the above hypothesis is correct, then it's a mistake to
think that we can get out of this crisis and back on a path of
sustainable growth only through the support of fiscal and
monetary policies," he said.
"It would be an illusion ... and a waste of time and
If policy-makers wanted to return economies to a path of
prosperity, they had to fundamentally reform the way economies
worked and competed in the global environment, he said,
suggesting the works of economists such as John Maynard Keynes
and Paul Samuelson as good reading material.
For a copy of the speech text, please see:
(Additional reporting by Emily Kaiser in Washington; Writing
by Deepa Babington and Krista Hughes; Editing by Ron Askew and