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Can Monetary Policy Make a Difference for Economic Growth and Inequality?

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  • Pierre Fortin
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    Abstract

    The basis for central bank policy aimed at price stability is the view that the benefits from very low inflation are "large and permanent," and that the related unemployment costs are "small and temporary." I question this belief in three ways: first, I point out that the quantitative evidence of large direct macroeconomic benefits from very low inflation is flimsy. Second, I show that the traditional inflation-unemployment tradeoff, which leaves no room for a permanent effect of monetary policy on output and employment, is a total failure as a description of the Canadian experience of the past decade. Third, I report on new evidence which shows that holding inflation below 2 percent (as the Bank of Canada has done since 1991) increases unemployment substantially and permanently, but that pushing inflation above 4 percent also generates higher permanent unemployment. Consequently, the optimal, unemployment-minimizing rate of inflation would be neither less than 2 percent nor greater than 4 percent, but would lie somewhere in between. I conclude that what is called for at this time is a monetary policy that is opportunistic on the expansionary side and brings the inflation rate into this range. Since poverty and unemployment are highly correlated, this new approach could also reduce poverty in Canada.

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    Bibliographic Info

    Article provided by University of Toronto Press in its journal Canadian Public Policy.

    Volume (Year): 29 (2003)
    Issue (Month): s1 (January)
    Pages: 223-232

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    Handle: RePEc:cpp:issued:v:29:y:2003:i:s1:p:223-232

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    1. George A. Akerlof & William R. Dickens & George L. Perry, 1996. "The Macroeconomics of Low Inflation," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 27(1), pages 1-76.
    2. Robert J. Barro, 1996. "Determinants of Economic Growth: A Cross-Country Empirical Study," NBER Working Papers 5698, National Bureau of Economic Research, Inc.
    3. Levine, Ross & Renelt, David, 1991. "A sensitivity analysis of cross-country growth regressions," Policy Research Working Paper Series 609, The World Bank.
    4. Sala-i-Martin, Xavier, 1997. "I Just Ran Two Million Regressions," American Economic Review, American Economic Association, vol. 87(2), pages 178-83, May.
    5. Tobin, James, 1972. "Inflation and Unemployment," American Economic Review, American Economic Association, vol. 62(1), pages 1-18, March.
    6. St-Amant, Pierre & Tessier, David, 1998. "Résultats empiriques multi-pays relatifs à l'impact des cibles d'inflation sur la crédibilité de la politique monétaire," Working Papers 98-23, Bank of Canada.
    7. Martin Feldstein, 1996. "The Costs and Benefits of Going from Low Inflation to Price Stability," NBER Working Papers 5469, National Bureau of Economic Research, Inc.
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