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Is Inflation Too Low?

  • William Poole

Inflation, as measured by the Consumer Price Index, seems to have settled at an annual rate of about 2 percent. Is that rate too low? In this article, William Poole, the president of the Federal Reserve Bank of St. Louis, states his belief that the Federal Reserve's target should be zero inflation, abstracting from measurement errors in the price indices. A zero rate would maximize the credibility of monetary policy and minimize distortions in the economy arising from uncertainty over the rate of inflation and from the tax code. One argument against zero inflation is that relative wages adjust more easily in an economy with a low, but positive, rate of inflation. This argument is not well supported in economic theory, and the evidence for it is weak. A second argument is that monetary policy may be ineffective at times because the nominal interest rate cannot fall below zero. This constraint is unlikely to be important in practice. The need for a negative real interest rate, which is possible only with positive inflation, will be much less at a zero rate of inflation because the economy will be more stable.

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Article provided by Cato Journal, Cato Institute in its journal Cato Journal.

Volume (Year): 18 (1999)
Issue (Month): 3 (Winter)
Pages: 453-464

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Handle: RePEc:cto:journl:v:18:y:1999:i:3:p:453-464
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  1. James Bullard & Steven Russell, 1998. "How costly is sustained low inflation for the U.S. economy?," Working Papers 1997-012, Federal Reserve Bank of St. Louis.
  2. Martin Feldstein, 1997. "Capital Income Taxes and the Benefit of Price Stability," NBER Working Papers 6200, National Bureau of Economic Research, Inc.
  3. Robert J. Barro, 1996. "Inflation and growth," Review, Federal Reserve Bank of St. Louis, issue May, pages 153-169.
  4. Brunner, Karl & Meltzer, Allan H., 1976. "The Phillips curve," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 1(1), pages 1-18, January.
  5. Erica L. Groshen & Mark E. Schweitzer, 1994. "The effects of inflation on wage adjustments in firm-level data: grease or sand?," Working Paper 9418, Federal Reserve Bank of Cleveland.
  6. Lazear, Edward P, 1981. "Agency, Earnings Profiles, Productivity, and Hours Restrictions," American Economic Review, American Economic Association, vol. 71(4), pages 606-20, September.
  7. Malcomson, James M, 1984. "Work Incentives, Hierarchy, and Internal Labor Markets," Journal of Political Economy, University of Chicago Press, vol. 92(3), pages 486-507, June.
  8. Lucas, Robert Jr, 1976. "Econometric policy evaluation: A critique," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 1(1), pages 19-46, January.
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