Author Description

This paper examines the existing theoretical and empirical literature on the possible benefits of low inflation, with the ultimate goal of arriving at a set of benefits in which a central bank can have genuine confidence rather than simply hopeful optimism. After an introduction, section 2 examines the familiar literature relating to inflation and the demand for real cash balances. Section 3 addresses the potentially most significant observable benefits of low inflation: the effect on the economy's growth rate of real output. Theoretical links between inflation and economic growth are examined, along with the evidence for such a relationship in the data. Section 4 looks at the interaction of inflation and an imperfectly indexed income tax system. Section 5 examines the benefits of low inflation that are not directly observable in the type of aggregate data that economists typically study. The likely relationship between inflation and allocative efficiency, as well as the direct effect of inflation on individual welfare, are discussed. Section 6 summarizes the benefits of low inflation in which central banks in moderate-inflation countries can sensibly believe. The final section argues that unobservable benefits of low inflation are central to defending the case for disinflation, and discusses two resulting policy challenges for the monetary authority.