More on real yields and inflation. The world economy and global policy making is at a fascinating juncture at the moment. Policy making over the last 30 years has been characterised by inflation targeting, a policy that has been largely successful with inflation below 2% in virtually all industrialised countries. Up to 2008, that was associated with the ‘Great Moderation’, the low volatility of global growth, a source of great satisfaction to policy makers. The Great Recession of 2008/2009 shattered that satisfaction and revealed it to be more like complacency. Since then, the world economy has recovered somewhat but it has been a weak recovery and with interest rates at or close to zero around the world, monetary policy is increasingly seen as impotent. Keynesian economists has been largely correct in saying we are caught in the liquidity trap and that an increased emphasis on fiscal policy is the way out. I am not disputing the fiscal policy argument for a moment. But there is another policy response that is required and that is higher inflation, or a higher inflation target. Real yields are -2% and with an inflation target of 2%, nominal yields will be on average 0% and so we will be stuck in the liquidity trap for some time. Given that policy makers cannot influence real yields, if they wish to get out of the liquidity trap they need to raise the inflation target, say to 4% or 5%. This is what makes policy making so fascinating; policy makers are trapped by the 2% target. Because high inflation was a ‘bad thing’ in the 1980s (and it was), policy makers cannot envisage an environment in which more inflation is actually a ‘good thing’ even though the world is crying out for more inflation. Policy making needs to be flexible. What is right in one era may not be right in another. Keynes was right in the 1930s, but Keynesianism was not the right policy in the 1960s and 1970s. Milton Friedman was largely right in the 1980s and monetarism worked as a means of defeating the high inflation of those times. But again circumstances have changed and new thinking and strategies are required. So far, sadly, there is not much sign of that happening.