DE EN. It provides a clear yardstick against which the public can objectively measure the Eurosystem's performance. It provides a clear anchor for inflation expectations. Thus, for example, when inflation is high, businesses have to channel more resources into portfolio management in order to avoid financial losses.
This is an inefficient use of productive resources that do not generate wealth to society. A low inflation rate reduces uncertainty. It has been observed that economies with high inflation also suffer from a more variable type of inflation. Uncertainty can have negative effects on expected profits from investment and, therefore, negative effects on long-term growth. Greater uncertainty also implies uncertainty with regard to relative prices, to the extent that there is a loss in price informative content for future prices and increase in trade margins.
All of this affects the efficient allocation of resources and lowers economic growth. Low inflation fosters investment. The most important decisions taken by individuals and businesses alike are usually long-term decisions: a decision to build a factory, to start a business, to pursue an education, to own one's home.
These decisions crucially depend on the degree of uncertainty regarding the future. Low and stable inflation is a macroeconomic indicator for stability that contributes greatly to the confidence of people and businesses for making investment decisions. A low inflation rate also prevents arbitrary redistribution of income and wealth, which particularly affect the poorest sectors of society, with the result that wage earners and retired people have fewer mechanisms to protect themselves against the inflationary erosion of their income.
Contract clauses on wages indexed to inflation are scarce or practically non-existent. For example, in Colombia, wages and pensions are adjusted once a year. Furthermore, the lower the income, the fewer mechanisms that will be used to offset inflation, such as savings or real estate acquisitions. Therefore, rising inflation means a redistribution of income that is detrimental for the poorest sector of the population.
In a speech given just after the Federal Open Market Committee announced its adoption of a monetarist-style policy approach in October , Volcker dismissed the notion that lowering inflation meant accepting permanently higher unemployment and suggested instead that the reverse was more likely to be the case.
Until this point, academic research or at least some of it had paved the way for improved policymaking. After , however, policymakers increasingly began to set the intellectual pace. Volcker's statements from this period in particular are remarkable in the extent to which they anticipate contemporary thinking about the crucial importance of low and stable inflation and inflation expectations. He repeatedly noted, for example, how instability in inflation and inflation expectations were "jeopardizing the orderly functioning of financial and commodity markets.
Under the Volcker-led Federal Reserve, annual core inflation fell from more than 9 percent in to just below 4 percent in Alan Greenspan, who succeeded Volcker as Fed Chairman in , continued to work to stabilize inflation and inflation expectations. Under Greenspan, the Federal Reserve gradually brought core inflation down further, to about 2 percent in recent years. The Greenspan era also saw important steps toward increased transparency at the Federal Reserve, which helped to clarify for the public the Federal Reserve's strong institutional commitment to price stability.
In a sense, Chairman Greenspan had the harder sell: As an economist would say, we might expect diminishing marginal returns to inflation reduction.
Yet I think subsequent events demonstrate clear benefits from the tenacity of the Fed under Greenspan. Lower inflation has been accompanied by inflation expectations that are not only lower but better anchored, so far as we can tell. Most striking, Greenspan's tenure aligns closely with the Great Moderation, the reduction in economic volatility I mentioned earlier, as well as with a strong revival in U.
Like Volcker, Greenspan was ahead of academic thinking in recognizing the potential benefits of increased price stability. Indeed, in recent years, academic research on monetary policy has caught up with the policymakers, providing new support for what I have termed the modern consensus, that price stability supports both strong growth and stability in output and employment.
Conclusion Price stability plays a dual role in monetary policy. Stable prices are desirable in themselves and thus are an important goal of monetary policy. But stable prices are also a prerequisite to the achievement of the Federal Reserve's other mandated objectives, high employment and moderate long-term interest rates. In particular, low and stable inflation and inflation expectations enhance both economic growth and economic stability.
The complementarity of price stability with the other goals of monetary policy is now the consensus view among economists and central bankers. That consensus has not been achieved easily, however, but is the product of many years of policy experience, policy leadership, and sustained economic analysis. No doubt we will continue to learn about the economy and economic policy, even as we benefit from the insights of those who went before us.
I am sure the Woodrow Wilson School, its faculty, and its students will continue to play an important role in that ongoing process. Bernanke, Ben S. Feldstein, Martin Romer and David H. Romer, eds. Friedman, Milton Miron, Jeffrey A. Phelps, Edmund S. Phillips, A. Romer, Christina D. Romer Volcker, Paul A. Volcker, , volume 1, Federal Reserve Board. Romer and Romer provide historical documentation of policymakers' support for the idea of a permanent inflation-unemployment tradeoff.
Return to text. Phillips' work actually focused on wage inflation rather than price inflation; subsequent work emphasized the latter. For example, Nobel-Prize-winning economist James Tobin is famously quoted as saying, "It takes a heap of Harberger triangles to fill an Okun gap," an admittedly jargon-laden way of saying that it was unlikely that the efficiency gains from lower inflation would compensate for the loss in output and employment associated with an aggressive effort to bring inflation down.
Quoted in Fischer , p. Search Submit Search Button. Toggle Dropdown Menu. Search Search Submit Button Submit. Please enable JavaScript if it is disabled in your browser or access the information through the links provided below. References Bernanke, Ben S. Fischer, Stanley Indexing, Inflation, and Economic Policy. MIT Press. Footnotes 1. Miron Return to text 2. Return to text 3. Feldstein Return to text 4. Return to text 5. Return to text 6. Friedman Return to text 7.
Fischer and Modigliani
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