Inside the world's oldest central bank, a new debate is ragingover a dilemma facing monetary authorities around the globe.

Policy makers at Sweden's 344-year-old Riksbank and elsewhereare arguing about how far they can look beyond their price mandatesand focus instead on economic growth, employment or financialstability when inflation threats are either not pressing or deemedto be passing. This marks a shift from three decades in whichcentral bankers battled inflation, an enemy they understood so wellthat most made it their singular emphasis in the 1990s.

“There are lots of things central banks are worried about at themoment, and inflation is not the highest priority,” said StephenKing, chief economist at HSBC Holdings Plc in London and a formerU.K. Treasury official. “As long as people believe central banksare committed over the longer term to price stability, there isleeway to play around with other objectives.”

How much they should lean toward alternate goals is contentious.At the Riksbank, Deputy Governor Lars E.O. Svensson, who oncetaught economics alongside Federal Reserve Chairman Ben S. Bernankeat Princeton University in New Jersey, says keeping inflation toolow hurts hiring, while Governor Stefan Ingves has said he worriesabout a debt bubble arising from low interest rates. The Riksbankleft its benchmark rate unchanged at 1.25 percent at its Octobermeeting.

Meanwhile, the Bank of England has ignored three years ofabove-target inflation as it tries to tackle slow growth in aneconomy just emerging from a recession. The European Central Bankfaces internal criticism for proposing to buy bonds ofcash-strapped nations. The Bank of Japan's rejection of moreradical policy options in a period of moderate deflation has becomea key political debate ahead of Dec. 16 elections.

Bernanke's Fed is leading the way toward a broader mission,thanks to its dual mandate of achieving stable prices and maximumemployment. After decades of emphasizing low inflation, it now aimspolicy at reducing the jobless rate.

The Federal Open Market Committee meets this week after Bernankeannounced an open-ended program in September to purchase $40billion in mortgage-backed securities a month. The buying — whichprobably will push the Fed's balance sheet beyond $3 trillion —will stop only when the labor market improves “substantially,” theFed said.

High Unemployment

Unemployment was 7.7 percent in November compared with 4.7percent before the 18-month recession began in December 2007.

The Fed may boost its holdings further by adding outrightpurchases of Treasuries, according to investors and analysts suchas Stephen Oliner, a resident scholar at the American EnterpriseInstitute in Washington, a research group that promotes freemarkets.

Such policies would be unthinkable if inflation wasn't dormantor forecast to be. The Fed's preferred price benchmark rose 1.7percent in October from a year earlier, near the 2 percentgoal.

“They are now poised to really blow up the balance sheet overthe next year or more as their prime tool to make sure they can dosomething about the high level of unemployment,” Oliner said.

Other central banks probably will follow the Fed's embrace ofmore stimulus in 2013, according to Nathan Sheets, New York-basedglobal head of international economics at Citigroup Inc. Citigrouppredicts that inflation in developed countries will slow to 1.7percent next year from 1.9 percent this year.

“The ongoing challenges facing the major economies, coupled withour subdued projections for inflation, suggest that central bankswill remain broadly expansionary through 2013 and probably wellbeyond,” said Sheets, Bernanke's top adviser on internationaleconomies from 2007 to 2011, in a Nov. 26 report.

With interest rates in major economies near zero andquantitative easing facing diminishing returns, policy makers mayconsider fresh unorthodox tools, according to economists at SocieteGenerale SA. The Bank of England already is trying to boost credit,the Bank of Japan has purchased assets beyond bonds and the SwissNational Bank has capped its franc against the euro.

The impact on stocks from central banks' concern for economicgrowth and employment is “unambiguously positive,” said AllenSinai, chief global economist at Decision Economics Inc. in NewYork.

Aggressive Stimulus

King's colleagues at HSBC cite aggressive stimulus as the mainreason for anticipating a return of about 9 percent next year inthe MSCI All Country World Index, which tracks 2,443 stocksworldwide. The index has risen about 12 percent this year, comparedwith a 9 percent decline in 2011.

“Explicitly in the U.S., or de facto in other countries, centralbanks are much more focused on the growth side” of their mandates,Sinai said. “They have no choice but to maintain easy policiesbecause the policy problem is too little growth, too highunemployment and too much debt.”

Inflation is low or appears well anchored elsewhere. In Sweden,consumer prices rose just 0.4 percent for the year ending Octoberand have been increasing less than 1 percent since July, about halfthe Riksbank's 2 percent target. Two-year break-even rates, ameasure of inflation expectations, are less than 0.5 percent. Asimilar indicator in Germany was about minus 1.8 percent lastweek.

There are several reasons why central bankers are taking on, orat least talking about, broader objectives. They are more confidentin their understanding of how inflation works after years of tryingto control it and now have a track record of capping expectations,which has “bought them room to be aggressive in other ways,” saidMark Zandi, chief economist at Moody's Analytics Inc. in WestChester, Pennsylvania.

“They worked for a quarter century to gain credibility, and theyshould use it,” he said.

Since central banks exist because their legislatures want themto be partners in economic prosperity, they can't maintainpolitical credibility by focusing only on low inflation amid highunemployment and weak growth, Sheets said.

In Japan, Shinzo Abe, head of the opposition Liberal DemocraticParty who is leading in polls to be the next prime minister, hascriticized the central bank for failing to escape deflation andsaid he wants “unlimited easing” until it achieves 2 percentinflation.

Falling Prices

Japanese consumer prices excluding fresh food fell in five ofthe six months through October, and the LDP's manifesto says it maylegislate to increase cooperation between the government andBOJ.

“We want to push ahead with anti-deflationary policies on a newlevel,” Abe said in a Nov. 29 debate. His call for “bold monetaryeasing” helped push the yen to a seven-month low against the dollarin November.

Even in countries where inflation is above target, centralbankers seem more concerned with escaping a cycle of joblessnessand economic malaise.

The Bank of England's 2 percent inflation goal has been breachedevery month since December 2009. Inflation was 2.7 percent inOctober, even though the economy this year fell into its firstdouble-dip recession since the 1970s and unemployment has stalledabove 7.5 percent since May 2009.

The U.K. central bank has held its benchmark rate at arecord-low 0.5 percent since March 2009 and bought 375 billionpounds ($601 billion) of assets. It has argued that trying to bringinflation back to the target too quickly could lead to economicpain.

In an interview with yesterday's Observer newspaper, U.K.Business Secretary Vince Cable said he would like the Bank ofEngland to have a more explicit target to bolster expansion.

While Governor Mervyn King said in an Oct. 9 speech it's “toosoon to bury” the concept of inflation targeting, he added it issometimes “justified to aim off” the goal to moderate the risk offinancial crises. Bank of Canada Governor Mark Carney, who willsucceed King in July, says he doesn't take a dogmatic approach andhas advocated flexibility.

Central bankers do have constraints. Some Fed officials havesaid their soaring balance sheet means selling the assets will bedifficult when the time comes to exit. Norway's central bankGovernor Oeystein Olsen signaled in September that policy makersare struggling to reconcile a potential housing bubble with lowinflation and exporter demands for rate cuts to cool kronegains.

Concerns about a buildup of household debt are restraining theRiksbank from cutting its benchmark repo rate further, GovernorIngves said.

Stretched Focus

The ECB, traditionally perceived by economists as the most loyalto its inflation target, also faces accusations from within itsGoverning Council that it is stretching its focus beyond pricestability with a proposal to buy bonds of countries that firstagree to fiscal goals. Spain is considering whether to sign up.

Such conditionality is “unprecedented,” said Larry Hatheway, thechief economist at UBS AG in London. “It does seem to move beyondwhat we've envisaged central banks are mandated to do.”

President Mario Draghi says the purchases will help unblock theso-called monetary transmission mechanism by encouragingcash-strapped banks to pass on the ECB's record-low 0.75 percentinterest rate. He said that meshes with the goal of ensuring pricestability.

With its economy in recession and unemployment at a record 11.7percent, the ECB forecast last week that inflation will averageabout 1.6 percent next year and about 1.4 percent in 2014, comparedwith 2.5 percent this year.

The greater risk to price stability “is currently falling pricesin some euro-area countries,” Draghi said Oct. 24 in Berlin. Sobond purchases under the ECB's Outright Monetary Transactionsprogram “are not in contradiction to our mandate; in fact, they areessential for ensuring we can continue to achieve it.”

In a sign the door is open for easing monetary policy further,Draghi said Dec. 6 there was a “wide discussion” on interest ratesat that day's meeting of his 23-member Governing Council before itleft policy unchanged. A majority of participants were open tocutting the rate, and there is a possibility of a reduction earlynext year if the economy doesn't pick up, three officials withknowledge of the council's deliberations said.

Bundesbank President Jens Weidmann has been alone on the councilin voting against the bond-buying strategy, on the grounds it'stantamount to printing money to finance governments, which theECB's founding treaty prohibits.

Safeguard Stability

“The intervention purchases must not be permitted to jeopardizethe capability of monetary policy to safeguard price stability,”Weidmann said Sept. 6.

Inflation expectations, as measured by the ECB's latest surveyof professional forecasters, are consistent on average with thecentral bank's goal. Even so, the economists gave an 8.8 percentprobability of inflation being over 3 percent in the medium term,up from 3.4 percent five years ago.

Traditional inflation-targeting regimes may be outdated, giventhe need of consumers, companies and governments to reduce debt,said Manoj Pradhan, a global economist at Morgan Stanley in London.Concentrating on prices could make that process costlier andgenerate even weaker growth and perhaps deflation, he said,suggesting instead a conditional goal that allows higher pricesuntil debts and growth are sustainable.

“By forcing central banks to focus on inflation, and indeed onrestricting inflation to its low pre-crisis level, these mandatescould possibly erode the very credibility that central banks arekeen to protect,” Pradhan said.

While officials shouldn't be negligent about price pressures,former Bank of Mexico Governor Guillermo Ortiz's experiencesuggests there is room to maneuver.

“The efforts that have been made to control and bring downinflation are precious commodities,” Ortiz, now chairman of Mexicanbanking group Grupo Financiero Banorte in Mexico City, said in aninterview. Policy makers “would certainly be wise not to losethat.”

When he became head of the central bank in 1998, he was battlinginflation in excess of 10 percent. As it fell into the singledigits, the central bank was able to broaden its scope. Now, withinflation low, monetary authorities are right to concentrate onstabilizing their economies and financial markets, he said.

“As we were feeling more comfortable with inflation, we wereable, as a central bank, to focus — although it was not in ourdirect competence — on potential growth in Mexico and structuralreforms and fiscal policy,” he said. “We could have hardly done”that without low inflation.

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