Zero Inflation Essays - Inflation, Monetary Policy,

Zero Inflation Introduction Hyper inflation has plagued most of the world's developing countries over the past decades. Countries in the industrialised world, too, have at times duelled with dangerously high inflation rates in the post WWII era. With varying degrees of success, all have employed great efforts to bring their inflation rates within acceptable limits. Generally, a moderate rate of inflation has been the ultimate goal. More recently, however, a few countries have pursued policies that strive to eradicate inflation altogether through complete price stability. This has proven to be a contentious enterprise, which clearly indicates that there is still no universally accepted solution to the inflation problem. Indeed, there is not even an agreed consensus regarding the source of inflation itself. The monetarist perception that the root of inflation is solely the excessive creation of money remains. So too does the belief that inflation originates in the labour market. And amongst a variety of others, t he opinion that inflation ?serves the critical social purpose of resolving incompatible demands by different groups? is also strong. This last, and more widely accepted, case shows that the problem is hardly a technical one; but rather a political one. It highlights the now unquestionable fact that politics and inflation are inextricably linked. And as with all inherently political issues, consensus is difficult, if not impossible, to achieve. But, political characteristics do provide flexibility. In some countries, high rates of inflation have clearly been compatible with rapid economic growth and fast rising standards of living. In such cases, it is quite reasonable to suggest that higher rates of inflation are acceptable--perhaps even necessary. In this setting, it is by no means clear that pursing a policy to stop moderate inflation is either required, or in the best interests of the mass of the population at all. While inflation guarantees that some will gain at the expense of others, the redistributions of income and wealth which do take place can, on normal value grounds, be quite desirable. In other circumstances, it may be quite desirable to place strict controls on inflation, or strive to keep it at ?zero' level. Policies aimed at virtual price stability have been in use by central banks in Europe, New Zealand, and Canada over the past few years. Such policies have been particularly focused in Canada. As noted by Pierre Fortin, ?the only objective the Bank of Canada has pursued since 1989 has been to establish and maintain the inflation rate at ?zero level', which it sees as a CPI inflation rate that is clearly below two percent? (italic added). To the surprise of many, it has been incredibly successful, achieving its objective several years before schedule. Although separated by only a few percentage points, Canada's policy is a sharp contrast to the moderate and balanced approach used in the U.S. ?Since 1989 the Federal Reserve has been satisfied with achieving an inflation rate of around 3 percent. In setting the interest rate, it has continued to pay explicit attention to real economic growth and employment, with the result that the U.S. unemployment rate is currently in the 5 to 6 percent range.? Based on this statistic alone, it can be argued that the more moderate U.S. approach has enjoyed greater success than the deflation oriented policy pursued by the Bank of Canada: Canada continues to be burdened with a higher rate of unemployment. Yet, it continues to believe that the unemployment costs of low inflation are ?transitory and small' . The directors of most European Central Banks also continue to support this dogma. Clearly, the credibility of the ?classical idea that the Phillips trade off between inflation and unemployment dis appears in the long run? is still very high throughout the world. But, in Canada, as in most of Europe, the waiting continues. This is not to suggest that the waiting game has been silent and entirely pleasant. Indeed, the relative lack (or lag!) of success of zero inflation policies and strict price controls has spurred much heated debate. As a case in point, more people are curious why Canada has exclusively focused on inflation cutting and turned a blind eye to the more balanced, and arguably more successful, approach adopted by the U.S.. Is