Speech

Is Inflation Too Low? 16thAnnualMonetaryConference CatoInstitute Washington,D.C. October22,1998 PublishedintheFederalReserveBankofSt.LouisReview,July/August1999,81(4),pp.3-10 What is today’s big monetary policy aboutasfavorableasetofinitialconditionsas issue? It is, surely, the extraordi- onecanimagineforgettingthroughfinancial nary volatility of the financial turmoilwithminimaleffectontherealsideof markets and the wide quality theeconomy. spreads that opened up between riskier bonds TheissueIwishtoexploreisthis:Iszero andTreasurybondsfollowingtheRussiandefault inflation,abstractingfrommeasurementerrorin in mid-August 1998. No one forecast these prob- thebroadpriceindexes,toolow?Ithinkzerois lems; the financial-market upset certainly was averynicenumber,especiallywhenitcomesto not a real, live policy issue back in the spring inflation.Butthereisaseriousargumentthatthe and early summer. economyislikelytoworkbetterwithamoderate Weshouldnotunderestimatethemagnitude inflationof,say,2or3percentperyear.Idisagree ofthecurrentdisturbanceintheU.S.financial withthatargument. system.Monetarypolicytodayis,Ibelieve,appro- Iwillconcentrateontwoargumentsformod- priatelyfocusedondealingwiththepossible erateinflation.Thefirstargumentholdsthatinfla- tionfacilitatesthesmoothoperationoflabor effectsofthefinancial-marketdisturbanceonthe marketsandtherebypromotesmaximumemploy- U.S.economy.Thesizeofthatdisturbanceand mentinthefaceofnominalwagerigidity.The thecircumstancessurroundingitaresounusual secondargumentcontendsthatinflation,viathe inthecontextofU.S.historythatpolicymakers Fisherrelationship,keepsnominalinterestrates mustconcentrateondealingwiththissituation fromfallingtooclosetothezerobound,and forthetimebeing. therebygivestheFedsufficientroomtoease— Thefinancialupset,however,willdisappear thatis,tocutrates—shouldarecessionappear fromtheradarscreenofpressingpolicyissuesas imminent. themarketssettledowninduetime.Allofus Inmyview,bothargumentsarewrong.Iwill willthenreturn—orshouldreturn—toanalyzing beginbyoutliningsomereasonswhyIbelieve longer-runissues.Withregardtothecurrentout- thatzeroinflationshouldbetheparamountobjec- look,IwillsayonlythatIamoptimisticthatwe tiveofmonetarypolicy. willworkthroughcurrentproblems,painfulas theyhavebeenformany,withnosignificantdam- agetotheU.S.economy.Myoptimismstemsfrom THE CASE FOR ZERO INFLATION theeconomy’sstronginitialconditionsoflow inflation,lowandstableinflationexpectations, AsChairmanAlanGreenspanhaspointedout andawell-capitalizedbankingsystem.Theseare onnumerousoccasions,oureconomy’sfineper- ThisspeechisreprintedwiththepermissionoftheCatoInstitute.ItwaspreviouslypublishedintheCatoJournal,Winter1999,18(3). ©1999,TheCatoInstitute. 1 MONETARYPOLICYANDINFLATION formancesincetheearly1990swasaccompanied zeroshouldbethetarget.First,maintaininga initiallybydeclininginflationand,morerecently, steadybutpositiveinflationrateprobablywould bylowandstableinflation.Clearly,theU.S.expe- beharderpoliticallythanmaintainingasteady rienceofthelastfiveyearscastsdoubtontheold zeroinflation.Thereasonisthatweliveinaworld claimthatfallinginflationwillinevitablybring wherebothpoliticiansandeconomistsoftenargue slowerrealgrowthorahigherrateofunemploy- thatjustalittlemoreinflationwouldgenerate ment.Thisexperiencealsosuggeststhatreducing positiverealeconomicgains.Ifweacceptthe thevariabilityofinflationneednotincreasethe argumentthat2percentinflationisokay,why variabilityofoutput,assomepeopleargue. not2.5percent?LetmeemphasizethatwhenI Althoughtheperformanceofothercountries advocatezeroinflation,Iamignoringmeasure- withlowinflationissomewhatmixed,mypoint mentquestions,suchaswhetherornotbiasexists issimplythatthereislittleevidencetosuggest intherelevantpriceindex.Asapracticalmatter, thatzeroinflationnecessarilyimpliesslowreal policyisprobablybestspecifiedintermsofa growth.Indeed,RobertBarro(1996)andothers measuredinflationrangethataccountsforour havereportedsystematicevidencetothecontrary. bestestimateofmeasurementerrors. Certainly,therearegoodreasonstoexpectthata AsecondreasonIadvocatezeroinflation zero-inflationmonetaryregime,sustainedover concernsthedistortionscausedbytheinteraction thelongrun,wouldenhanceaneconomy’s ofinflationwiththetaxcode.Inflationindexing performance. isincomplete,especiallyforinvestmentincome, Ifthemonetaryauthorityiscommittedcredi- becausenominalinterestincomeandnominal blytozeroinflation,thenonesourceofinterfer- capitalgainsaresubjecttotax.MartinFeldstein encewiththeefficientworkingofmarkets— (1997)hasestimatedthatreducinginflationfrom uncertaintyaboutexpectedinflation—wouldbe itscurrentlevelofabout2percenttozerowould reduced.Inflationuncertaintymakesitdifficult yieldsubstantial,permanentrealincomegains. forindividualsandfirmstodistinguishchanges TheoreticalanalysisbyJamesBullardandSteven inrelativepricesamonggoodsandservicesfrom Russell(1998),andothers,alsosuggeststhattax movementintheaggregatepricelevel.Mistakes distortionscosttheeconomysubstantialreal intheallocationofresourcesaremorelikelyto performanceathigherratesofinflation. occurbecauseofthisuncertainty,withrealgrowth Inshort,Ithinkthecaseisstrongthatmone- consequentlylessthanitcouldbe. tarypolicyshouldaimforzeroinflationasitspara- Byconfusingthemeaningofindividualprice mountobjective.Moreover,Irejecttheapproach changes,inflationuncertaintyalsoraisesuncer- thatzeroinflationmustbeshowntobesuperior taintyabouttheprospectsofinvestmentreturns. toapoorlyspecifiedalternativeofsomepositive Arisingrateofinflationcanleadbothborrowers inflation.Theburdenofproofreallyshouldfall andlenderstobeoverlyoptimisticaboutlikely onthosewhocontendthatpositiveinflationis returns,resultingininefficientresourcecommit- better.So,letmenowconsiderthearguments ment.Ifthepriceexpectationsthatareassumed advancedforapositiverateofinflation. whenfundsarecommittedarenotrealized,bor- rowersmayencounterdifficultyrepayingtheir debts,whichinturnputsstressonlenders.Thus, LABOR MARKET ARGUMENTS itisreasonabletoexpectthateliminatinguncer- taintyabouttherateofinflationwillenhance, Oneperennialargumentinfavorofpositive althoughobviouslynotguarantee,financial inflationisthatcertainwagesmustfallrelativeto stability. otherpricesorotherwages,andinflationallows Presumably,toeliminateuncertainty,therate thisadjustmentofrealwagestooccurintheface ofinflationneednotbezero,butsimplypredict- ofnominalwagerigidity.Thecenterpieceofthis able.Foratleasttworeasons,however,Ibelieve argumentistheclaimthatdownwardnominal 2 IsInflationTooLow? wageadjustmentsoccurtooinfrequentlytobe forsometime.Suppose,also,thattheFed’scom- consistentwithflexiblerealwagesinaworld mitmenttomaintainingthisregimeisclear.In wheremicroeconomicshockscontinuouslyalter suchanenvironment,nominalwagerigidity, therelativepositionsofparticularfirms,indus- accordingtothegrease-the-wheelsargument, tries,oroccupations.Withzeroinflation,theargu- wouldgeneratealargeinefficiencythatinflation— mentgoes,rigidnominalwagespreventoptimal nowzero—wouldnolongerameliorate.This adjustmenttorelativepricedisturbanceswith inefficiency,however,isexactlywhatshould theresultthatemploymentvariesinefficiently. makeusdoubtthatnominalwagerigiditywould Therefore,alittleinflationisagoodthingbecause continuetoexist.Themainfunctionoftheprice itallowswagestofallrelativetootherprices; systemistoallocateresourcesbysettingrelative inflation“greasesthewheels”oflabor-market prices.Competitiveforceslikelywouldeliminate adjustment. anythingthatinterfereswithrelativepriceadjust- ment,particularlyiffailuretoadjustisverycostly, Zero Inflation in a Different Regime unlessthereissomecompellingreasonforitto exist.Couldweimaginethatnominalwagerigid- Thereare,inmyopinion,seriousflawsat itywouldcontinueduringasustained10percent threelevelsofthisargument.First,theargument deflation?Ofcoursenot.Why?Theprivatecosts claimsthatnominalrigiditycreatesalargeineffi- ofinterferingwithrelativepriceadjustmentwould ciencythatinflationameliorates.But,iftheclaim betoohigh.Itmaytakelongerforcompetitive ofalargeinefficiencyistrue(andIwillquestion forcestoerodenominalrigidityunderzeroinfla- itlater),asimpletheoreticalargumentcreates tion,buttheprincipleisthesame. thepresumptionthatnominalwageswouldnot Keepinmindthatthemagnitudeofongoing continuetobestickyinazero-inflationregime. resourcereallocationinU.S.labormarketsdwarfs Thereissomedisputeabouttheextentto theemploymentgrowththatmakesheadlineson whichnominalwagesaredownwardlyrigid.But, thefirstFridayofeverymonth.Jobsappear,jobs nodoubtsomeemployershavefounditdifficult disappear,andpeoplemoveintoandoutofthem toreducenominalwagesduringtheperiodscov- atratesfarhigherthannetemploymentgrowth. eredbythemostpopulardatasources.Onedata ThisisprimafacieevidencethatU.S.labormar- source,thePanelStudyofIncomeDynamics, ketsdonotsufferfromanymassiveinefficiency. startedduringthelate1960s.Imentionthesample Ifnominalwagerigiditycreatessignificant periodbecausemakinganempiricalregularity economicinefficiency,itseemsentirelyplausible thefoundation,ratherthananimplication,of thatitisperpetuatedbyinflation.IadmitIdonot economictheoryalwaysisdangerous.Robert knowforsure.Basedonthecurrentstateofeco- Lucas(1976)elegantlydemonstratedthispoint nomictheory,however,Ithinkwemustfavorthe morethan20yearsago.Totheextentthatdown- presumptionthatinefficientwagerigiditywould wardnominalwagerigidityexists,itpresumably disappearinazero-inflationeconomy.Thisposi- servessomeeconomicfunction.Afterall,putting tionmakessenseifwetakeeconomictheory minimumwagelawsaside,fixednominalwages seriously. arenotrequiredbylaw.Wecannotassumethat thepresentdegreeofwagerigidity—whateverit Other Mechanisms for Relative Wage is—wouldcontinueintoadifferentinflation Adjustment regime.Indeed,acompellingcasecanbemade thattheextentofwagerigidityweobservewould Asecondflawinthegrease-the-wheelsargu- notsurviveinazero-inflationregime. mentisthatitimaginesonlytwomechanismsfor Consideranenvironmentwhere,broadly achievingadjustmentstoaworker’srelativewage: speaking,theannualchangesinbroadprice Eithercutthenominalwage,orletallotherprices indexesusuallyareclosetozeroandhavebeen arounditrise.Infact,theworkingsoflabormar- 3 MONETARYPOLICYANDINFLATION ketssuggestatleasttwoothermechanisms,and inpricechangestendstorisewithhigheraggregate sothepresenceofnominalwagerigidity—were inflation—thatunderlaythecaseforpursuinga ittoexist—mightnotbeahindranceinazero- positiverateofinflation.Thus,theclaimthatinfla- inflationworld. tionhelpstheeconomycopeefficientlywithrela- First,averagecompensationtendstoriseover tivepricechangesissuspectimmediately,since time,asoverallproductivityimproves.Thus,in thereismorerelativepricevariationtocopewith azero-inflationenvironment,nominalwagesmay ifthereismoreinflation. notneedtofall,eveninsomedecliningoccupa- tions.Proponentsofthegrease-the-wheelsview Labor Market Costs as Well as Benefits sometimesignorethismechanism. Overall,Ibelievethatthebenefitsofinflation Internallabormarketsprovideyetanother aslabor-marketgreaseareexaggerated.Further- adjustmentmechanism.Compensationtendsto more,inflationitselfseemstoworsentheproblem increasewithseniority,partlybecauseofan itostensiblyalleviates.Inadditiontothesetheo- individual’saccumulationofhumancapital. reticalarguments,wenowhavesomedirect EdwardLazear(1981)hasarguedthatanupward- evidence,suppliedbyEricaGroshenandMark slopingpathforearningsalsoactsasamechanism Schweitzer(1996,1999).Theyrecognizethat toovercomeagencyproblemswithinthefirm. compensationtypicallyissetforatleastayear, JamesMalcomson(1984)andothershaveargued andthatthereare,inessence,twopiecestoa thatpromotionsmayplayasimilarrole;rather firm’swage-settingprocess.First,management thansimplyfillingpositionsnecessaryforthe decidesontheoverallchangeinthewagepool, technologicaloperationofthefirm,promotions basedinpartontherateofinflationexpectedto providenecessaryincentivesforthoseatlower prevailduringthefollowingyear.Thiswagepool, levelsofthehierarchy. ineffect,setsthefirm-widebudgetconstraint. Thecommonthemeintheseobservations Second,individualwagesandsalariesareadjusted aboutinternallabormarketsisthatanindividual inawaythatsatisfiesthebudgetconstraint.This workertypicallywillexpectanincreasingreal two-stepprocessisexplicitinmanyorganizations. wage.Therefore,thekindofbaseadjustment Mistakesoccurduringthefirststagewhen achievedbyinflationcanalsobeaccomplished managersmisforecastinflation.“Sand-in-the- bydelayingwagechangerelativetoanindividual’s wheels”effectsoccurifhigheraveragelevelsof upward-slopingrealwagepath. inflationresultinmoreinflationvariability,caus- Ofcourse,thereisasegmentofthelabor inglargerinflationforecastingerrors.Aconse- marketwherelittlehumancapitalaccumulation quenceisthatinflationwillcausemoreinterfirm existsandlong-termimplicitcontractsarerare. variationinwageadjustment.Greaseeffectsoper- But,forobviousreasons,thisisexactlytheseg- ate,asIoutlinedearlier,andimplymoredisper- mentwhereturnovercostsarelowonboththe sionofinteroccupationalwageadjustment.The supplyanddemandsidesofthemarket.Hence, greaseeffectsshouldtaperoffasinflationrises anynominalwagerigiditythatispresentisnot becausesomelevelofinflationenablesemployers especiallycostly. tomakealloftherelativewageadjustmentsthey wouldmakeinafrictionlesslabormarket.Because theyviewwagesettingasatwo-stageprocess, INFLATION AND RELATIVE PRICE GroshenandSchweitzerestimatethegreaseand VARIABILITY ARE LINKED sandeffectsseparately.Theyfindevidenceof Thethirdflawinthelabor-marketcasefor botheffects,withsandeffectsrisingrapidlywith positiveinflationisperhapsthemosttransparent. theinflationrate.Comparingthegreaseandsand Inflationtendstoincreasethesortofmicroeco- effectsdirectly,GroshenandSchweitzerfindthat nomicshocks—becausecross-sectionalvariation evenforlowinflationratesthenetbenefitofinfla- 4 IsInflationTooLow? tionisstatisticallyindistinguishablefromzero, withsettingashort-termnominalinterestrate— althoughpointestimatesofthegrossbenefitdo intheUnitedStates,thenominalfederalfunds slightlyexceedestimatesofgrosscost. rate.Ahighernominalfederalfundsrateisoften Onemightquibblewiththespecificsoftheir describedasatighterpolicy,whilealowernom- empiricalstrategy,butGroshenandSchweitzer’s inalfederalfundsrateisdescribedasaneasier emphasisonevaluatingcostsaswellasbenefits policy.Whentheeconomyisweak,themonetary isabsolutelycorrect.Fromthestandpointoflabor authoritieslowerthenominalfederalfundstarget markets,Ithinkitisfairtosaythattheevidence inanefforttostimulateinterest-rate-sensitive ofnetbenefitsfromaninflationarymonetary sectorsoftheeconomy.Soaccordingtothisview, policyisslimtonone. whenarecessionhits,thecurrentlevelofthe federalfundsratedeterminesthenumberof basispointstheFedhasavailabletocombatthe THE ZERO NOMINAL INTEREST recession:thelowertheinitialfundsrate,the RATE BOUNDARY lessscopeforsubsequenteasing.Asyoumight guess,Idislikethischaracterizationofmonetary Nowletusconsiderwhetherconcernsabout policy,butletmefinishthestory. conductingcountercyclicalmonetarypolicyina Ofcourse,financialmarketparticipantsare low-inflationenvironmentcanjustifyapositive interestedmainlyintherealinterestrate,notthe rateofinflation.Specifically,doespricelevel nominalinterestrate.AsimpleFisheriandecom- stabilitycausespecialproblemsformonetary positiondividesanynominalinterestrate(with policybecausenominalinterestratescannotbe zerodefaultrisk)intotwomajorcomponents—a lessthanzero? realcomponentdeterminedbyequilibriumcon- Thezero-boundviewisanoldandmuch ditionsintheeconomyandanominalcomponent debatedoneinmacroeconomics.Withrisinginfla- determinedbytheexpectedinflationrate. tionduringthe1970sandearly1980s,theissue Thezero-boundviewholdsthattheexpected largelybecamemoot,aspolicymakersscrambled inflationcomponentofnominalinterestrates togetinflationbackundercontrolandtoregain moveslittleoverperiodsaslongasayear,sothat lostcredibility.Recently,however,thetopichas adjustmentsinthenominalfederalfundsrate resurfacedasinflationratesintheindustrialized mainlychangerealreturnsattheveryshortend countrieshavefallenandstayedlowduringthe ofthetermstructure.Movementsinshort-term 1990s,andascentralbanksaroundtheworld ratesthenleadtoadjustmentsinlonger-termreal haveadoptedinflationtargetingasamethodof interestrates. achievingandcommittingtopricestability. Whathampersstabilizationpolicyinalow- Thezero-boundviewholdsthatmoderate inflationenvironment,accordingtothezero- inflationaidsintheimplementationofstabiliza- tionpolicybykeepingnominalinterestratesfrom boundview?Ifinflationiszeroandexpectedto fallingtoolow.Thebottomline,accordingtothis remainthatway,thentheexpectedinflationcom- argument,isthataninflationtargetofzerointer- ponentofnominalinterestratesiszero,andthe fereswiththeattemptsofmonetarypolicymakers nominalrateisloweronaveragethanitwould tostimulateaneconomyinrecessionbecausethe beinaworldofpersistentinflation.Thus,ina nominalinterestrateobviouslycannotfallbelow recession,theFedwouldhavelessroomtocut zero.Putanotherway,withmoderateongoing interestratesbecauseofthezeronominalbound. inflationthepolicymakershaveroomtopush Theendresult,accordingtothisview,isalonger therealrateofinterestbelowzero,whichthey anddeeperrecessionthanwouldotherwisebe cannotdowhenthesteadyinflationrateiszero. thecase.Themessageisclear:IftheFedisto Thezero-boundstorybeginswiththecom- helptheeconomyintimesofdistress,nominal monplaceideathatmonetarypolicyisconcerned interestratesmustbekepthighenoughinnormal 5 MONETARYPOLICYANDINFLATION times,whichrequiresmaintainingamodestrate nominalinterestratesasindicatorsofthestance ofinflation. ofmonetarypolicycanbetragicallymisleading. Thezero-boundviewhasraisedmanycounter- Wemightalsodowelltorememberthatdur- argumentsovertheyears.Perhapsmostobviously, ingthelate1950sandearly1960s,thenominal thisviewplacesheavyemphasisontheideathat annualizedyieldonthree-monthTreasurybills monetarypolicycanbeusedtofinetunethe fluctuatedaround3percent,whiletheyieldon macroeconomy,downplayingwell-knowncon- 10-yearTreasurybondswasaround4percent. cernsthatattemptstofinetunecancontributeto Theseyieldsarebelow,butinthegeneralballpark, ofthoseweobservetoday.Consumerpriceindex economicinstability.Leavingthatissueaside, inflationduringthatperiodaveragedabout2 however,therearestillseveralreasonstodoubt percentonayear-overyearbasis—nottoodifferent thevalidityofthezero-boundargumentforpur- fromtoday’sinflationrate.So,whilewehave suingapolicyofpositiveinflation. notseenasustainedzero-inflationenvironment intheUnitedStatesduringthepostwarera,we Monetary Policy Is Fundamentally Not haveseenanenvironmentnottoodifferentfrom About Nominal Interest Rates today’sintermsofrelativelylowinflation.And First,wemustrememberthatnominalinterest duringthelate1950sandearly1960s,therewas ratesdonotindicatethetruestanceofmonetary noobviousimpedimenttotheoperationofmone- policyeventhough,asapracticalmatter,theFed tarypolicyjustbecauseinflationwaslow. implementsshort-termpolicybytargetingthe nominalfederalfundsrate.Thismethodofimple- Inflation and Output Variability mentationhasbeeneffectiveinrecentyears. Therelativestabilityofoureconomyin Controllingthefundsrateisnot,however,an recentyearssuggeststhatlowinflationprobably endinitself.Fundamentally,monetarypolicyis contributesbothtolessinflationvariabilityand reflectedinthegrowthofthemoneystockand, tolessoutputvariability.Throughoutthe1970s ultimately,therateofinflation.Sotheideathat andearly1980s,bycontrast,wheninflationrose centralbankersaresomehowtrappedifthenomi- sharplyandthenfellabruptly,theUnitedStates nalshort-terminterestratenearszeroseemsquite sufferedthroughthreerecessions,includingtwo astretchtome.Weareinthebusinessofproviding ofthemostsevererecessionsofthepostwarera. liquiditytothemacroeconomy,andifthesitua- Tobesure,duringthatperiod,theU.S.economy tioncallsforit,liquiditycanalwaysbeinjected, washitwithshocksfromexternalsources,butat regardlessofthelevelofnominalinterestrates. thesametimemonetarypolicywasdecidedly ThefirstyearsoftheGreatDepressionoffer uneven—resultinginasubstantialinflationthat perhapstheclearestillustrationthatmonetary causedbothunnecessarydistortionsandproved policyisfundamentallyaboutprovidingliquidity difficulttotame.Thus,thepostwarexperience andnotaboutcontrollingnominalinterestrates. stronglysuggeststhatlowerinflationisassociated Duringthattime,nominalinterestrateswere withlessvolatileinflation,andlowerinflation low,whichseemedtoindicatean“easy”mone- volatilityisreflectedinlowervolatilityinreal tarypolicy.ButasMiltonFriedmanandAnna output.Eveninazero-inflationenvironmentthe Schwartz(1963)havenoted,from1930to1933 lowerboundonnominalinterestratesprobably wouldnotbeaproblemforstabilizationpolicy themoneystockwasfallingrapidly,indicatinga becauseeconomicvolatilityitselfwouldlikely fartighterpolicythanwasintended.Ofcourse, belower. thatpolicywasanunmitigateddisaster,asboth outputandpricesfellbyathirdandtheunem- Nonlinear Effects Near Zero ploymentratehit25percent.Thatexperience,as wellasother,lessdramatichistoricalepisodes, Afinalreasontodoubtthatmonetarypolicy shouldmakeitobviousthatblindadherenceto wouldrunagroundinazero-inflationworldstems 6 IsInflationTooLow? fromthenonlinearityofinvestmentdemand. Todayweareenjoyingthebenefitsofalow Thisnonlinearityimpliesthatagiveninterest andcomparativelystablerateofinflation.Inour ratechange,measuredinbasispoints,maywell presentstate,weshouldnotforgetthehighcosts havealargerimpactwheninterestratesarelow ofinflation.Inflationmakesplanningdifficult thanwhentheyarehigh. forindividualsandfirms,itinterfereswiththe Muchofthethinkingbehindthezero-bound operationofmarkets,anditinteractsinsidiously viewiscenteredontheextrapolationoflinear withthetaxcodetodiscouragesavingandinvest- effectstoverylowinterestrateenvironments.In ment.Moreover,inflation’seffectsarefeltmost muchoftheworkonthisissue,theaverageeffects acutelybymembersofsocietywhoareeconomi- ofshort-runmonetarypolicychangesareesti- callythemostvulnerable.Inarguingforapositive matedusingpostwardata,whichincludemany rateofinflation,therefore,theburdenofproof yearsofhighinflation.Thereislittlereasonto shouldrestwiththosewhocontendthatour thinkthatcoefficientsestimatedfromanenvi- economywouldperformbetterwithinflation ronmentofrelativelyhighinflationwouldbe thanwithoutit.Inflationproponentsalsoshould goodproxiesforthecoefficientsinthenew explainhowamoderaterateofinflationcould circumstance. bemaintainedwithoutinchingeverhigher.In Wemightexpectthatagivenbasispoints myview,thecaseforpositiveinflationhasnot changeinthenominalfederalfundsratetarget beenproven. wouldhavealargerimpactwheninterestrates Acentralbank’ssinglemostimportantjobis arelower.Certainly,thereisnoreasontoexpect preservingthevalueofthenation’smoney.Mone- thattheresponseofinvestmenttochangesinthe tarypolicyhassucceededifthepubliccanreason- nominalinterestrateislinear.Atanypointintime ablytrustthatadollarwillbuytomorrowwhatit countlessinvestmentprojectsareavailable,and willbuytoday.Atthispoint,inflationwillhave asthenominalcostoffundsmoveslower,the ceasedtobeahindrancetothesmoothfunctioning netpresentvalueofmanymoreoftheseprojects ofourmarketeconomy.Icannotpromisethat becomespositive.Accordingly,investmentwould pricestabilitywillmeananendtothebusiness beunboundedatverylowrealinterestrates, cycle,tounemployment,ortooccasionalfinancial implyingthattheFedcouldconductacounter- distress.Indeed,Iamwillingtobetthatafew cyclicalpolicyjustasactivelyandeffectively yearsfromnowwewilllookbackon1998and wheninterestrateswerelow,evenifthenominal concludethatthestabilityoftheinflationenviron- federalfundsratetargetwasnearzero. mentwasimportanttocontainingthefinancial- marketupsetthatstartedinAugust. Weshouldnotbeseducedbyargumentsthat ZERO INFLATION IS NOT TOO alittleinflationisagoodthing.Lookattherecord: LOW Overthepast50years,oureconomyhasper- Tosummarize,itseemstomethatneither formedbetterwheninflationwaslowthanwhen theargumentsaboutwagestickinessnorthose itwashigh.Theresimplyisnocompellingevi- concerningthezeroboundfornominalinterest dencethatwecouldfostersustainedeconomic ratesmakeaconvincingcasethatmonetarypolicy growthbypursuinganinflationarymonetary shouldaimforapositiverateofinflation.Instead, policy.Theevidencepointsintheotherdirection. Ibelievethelogicandtheevidencebothsuggest Thus,Iamconfidentthatoureconomy’slong-run thattheappropriategoalformonetarypolicy performancewouldbeenhancedbyamonetary shouldbepricestability,thatis,along-runinfla- policythataimsat,achieves,andmaintainsa tionrateofapproximatelyzero. zerorateofinflation. 7 MONETARYPOLICYANDINFLATION ACKNOWLEDGMENT Groshen,EricaL.andSchweitzer,MarkE.“The EffectsofInflationonWageAdjustmentsinFirm- IoweagreatdebttotheSt.LouisFedresearch LevelData:GreaseorSand?”FederalReserveBank department,andespeciallytoDavidWheelock, ofNewYorkStaffReportNo.9,January1996. JimBullardandJoeRitter,forassistanceinprepar- ingtheseremarks. Groshen,EricaL.andSchweitzer,MarkE. “IdentifyingInflation’sGreaseandSandEffectsin theLaborMarket,”inMartinFeldstein,ed.,The REFERENCES CostsandBenefitsofPriceStability.Universityof ChicagoPress,1999,pp.273-308. Barro,RobertJ.“InflationandGrowth.”Federal ReserveBankofSt.LouisReview,May/June1996, Lazear,EdwardP.“Agency,EarningsProfiles, pp.153-69. Productivity,andHoursRestrictions.”American EconomicReview,September1981,pp.606-20. Bullard,JamesB.andRussell,StevenH.“HowCostly IsSustainedLowInflationfortheU.S.Economy?” Lucas,RobertE.,Jr.“EconometricPolicyEvaluation: FederalReserveBankofSt.LouisWorkingPaper ACritique,”inKarlBrunnerandAllanH.Meltzer, 97-012B,March1998. eds.,ThePhillipsCurveandLaborMarkets. Carnegie-RochesterConferenceSeriesonPublic Feldstein,Martin.“CapitalIncomeTaxesandthe Policy,NorthHolland,1976,pp.19-46. BenefitsofPriceStability,”NBERWorkingPaper 6200,September1997. Malcomson,JamesM.“WorkIncentives,Hierarchy, andInternalLaborMarkets,”JournalofPolitical Friedman,MiltonandSchwartz,AnnaJacobson.A Economy,June1984,pp.486-507. MonetaryHistoryoftheUnitedStates,1867-1960. PrincetonUniversityPress,1963. 8

William Poole (1998, October 21). Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/speech_19981022_poole

@misc{wtfs_speech_19981022_poole,
  author = {William Poole},
  title = {Speech},
  year = {1998},
  month = {Oct},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/speech_19981022_poole},
  note = {Retrieved via When the Fed Speaks corpus}
}