You Can't Eat Low And Stable Inflation Expectations

A blog about business and economics.
March 24 2012 1:04 PM

You Can't Eat Low And Stable Inflation Expectations

Over at the Economist, Ryan Avent notes that central bankers and economic elites more generally in the United States and European Union regard the creation of low and stable inflation with well-anchored expectations since the mid-1980s as a major achievement and they're loathe to do anything that has the slightest chance of upsetting it. They are willing, in other words, to tolerate the certainty of a years-long period of mass unemployment in order to avoid the risk of undoing the 2 percent inflation anchor. Avent judiciously notes that not only do they seem to wildly overstate the odds of this happening, they manage to even more wildly overstate the benefits of their success:

Moreover, is it clear that the net benefits of this defeat of inflation volatility are so great? Perhaps they are; a simple look at the performance of macroeconomic aggregates in the postwar period versus the period from 1984 to now isn't at all conclusive. There is a real cost to extreme inflation aversion. Central bankers have done a pretty woeful job explaining the benefits of this policy, and they should be roundly criticised for this failure.
 
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To be less judicious about it, consider the sad fate of China and India, two large economies who have not succeeded in generating low and stable inflation:

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Obviously there's some welfare cost to this. America's low stable inflation rate is very predictable which is convenient every time people need to set a price or negotiate a deal. At the same time, China and India make it perfectly clear that higher and less stable rates of inflation are perfectly consistent with robust growth in real output. What's more, they've specifically done a much better job of weathering the global financial crisis without experiencing any quarters of output contraction. Eliminating the constraints of the zero bound and paranoia about inflation expectations, hardly solves all the economic problems are country could have—but it does seem to solve the particular problem of a nominal shock creating a huge real problem.

Matthew Yglesias is the executive editor of Vox and author of The Rent Is Too Damn High.

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