Inflation Essay

Inflation Essay

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By the beginning of the 1980s, double-digit rates of inflation had become so pervasive among industrialized economies that they were viewed as a major deterrent to global economic growth. Since then, an explicit policy goal of low inflation has become a mantra for policymakers, and many countries, such as the U.K., New Zealand, Australia, Japan, Sweden, and the eleven countries under the European Central Bank (ECB), have enacted fundamental reforms to achieve that goal. Specifically, they have made their central banks more independent and thus insulated them from the temptations of inflationary finance; furthermore, in most of these cases, as well as in the U.S., central banks have practiced a greater degree of openness or transparency about monetary policy decisionmaking to give the private sector a better opportunity to monitor their activities.

Today, these countries can claim considerable success in reducing both inflation and inflationary expectations. For example, despite the run-up in energy prices in 2000, consumer price inflation rates from 1999.Q3 through 2000.Q3 fell to 3.5% in the U.S., to 3.2% in the U.K., to 1.6% in the EMU countries, to 2.7% in Canada, to 0.9% in Sweden, and to 3.0% in New Zealand. Japan, with an inflation rate of -1.2%, is something of a special case, as it is just beginning to emerge from a prolonged recession.

With inflation rates now in the low single digits, attention has become more narrowly focused on the problem of determining quantitatively what the "optimal" inflation rate should be. Evidence to date suggests that policymakers�iews have coalesced, however tentatively, around a "2% solution" to this question. For example, consider these explicit inflation targets: 2.5% for the...


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...steps to lower the inflation rate and to ensure that it remains low. The question that many are grappling with is how low should they go? The evidence suggests that there is a perhaps tentative coalescence of views around the choice of 2%. Research to date would support further reductions in the inflation rate to zero or to a mild deflation. However, further research is needed both on the functioning of economies at near-zero nominal interest rates, as emphasized recently by Lucas (2000), and on the nature and influence of various types of contractual arrangements, including financial as well as labor contracts, around which an important share of economic activity is organized. The results of this research may enhance the arguments for an outcome closer to the "2% solution," but in any case is likely to suggest that a refinement of these inflation goals is called for.

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