The Central Bank Should Aim for Zero Inflation Essay Example

by Paul Volcker in the early 1980s, when he tightened monetary policy and reduced inflation from about 10 percent in 1980 to about 4 percent in 1983. Although in 1982 unemployment reached its highest level since the Great Depression, the conomy eventually recovered from the recession, leaving a legacy of low inflation. Today Volcker is considered a hero among central bankers. Moreover, the costs of reducing inflation need not be as large as some economists claim. If the Federal announces a credible commitment to zero inflation, it can directly influence expectations of inflation. Such a change in expectations can improve the short-run tradeoff between inflation and unemployment, allowing the economy to reach lower inflation at a reduced cost.

The key to this strategy is credibility: People must believe that the Federal is actually going to carry through on its announced policy. Congress could help in this regard by passing legislation that made price stability the Fed’s primary goal. Such a law would make it less costly to achieve zero inflation without reducing any of the resulting benefits. One advantage of a zero-inflation target is that zero provides a more natural focal point for policymakers than any other number.