Tuesday, February 16, 2010
This is not a new story, at least not to me. I co-authored a paper published in 1994 with Hal McClure and Tom Willett in which we argued that the optimal inflation rate was probably zero for most economies if there was a tradeoff of even 1% of GDP growth for a 10% anticipated inflation rate. Developing countries are usually assumed to have a smaller tradeoff. There are non-linearities or threshold effects involved as well. (I don't know of a summary paper that covers the literature and none were obvious from looking on Google Scholar, at least not since Bruno and Easterly . If anyone knows one, please put in comments.)
To be sure, there are plenty of studies suggesting modest increases in the rate of inflation from the levels currently targeted by many central banks would not be problematic�here, for example. But the point is that the evidence is not clear cut that an increase from an average rate of inflation in the neighborhood of 2 percent to the neighborhood of 4 percent would be innocuous. And there is always this element, noted by John Taylor in the aforementioned Wall Street Journal article:
"John Taylor, a Stanford University monetary-policy specialist who served in the Bush administration Treasury department, says that inflation could become hard to constrain if the target is raised. 'If you say it's 4%, why not 5% or 6%?' Mr. Taylor said. 'There's something that people understand about zero inflation.' "
Arguing for higher inflation targets at a time like this is a call for cheap credit, which seems like trying to do the same thing we did in 2004-05 while hoping for a different outcome.