Monetary Policy Issues in a Low Inflation Environment*

A remarkable feature of the economic performance of industrial countries in the postwar period is that there has been persistent inflation, in clear contrast to the XIX century and the period up to World-War I, which saw significant fluctuations in the general price level around a fairly stable mean. However, when one looks at inflation over the past thirty years, it is striking that, in contrast to the relatively high rates of the late sixties, the seventies and – in many European countries – the early eighties, inflation has since attained low rates over the past few years (Figure 1). For instance, while inflation in the OECD was, on average, 10.2% in the seventies and 9.2% in the first half of the eighties, it came down to 5.1% in the second half of the eighties and to 2.8% in the nineties, running in 1999 at 1.4%. In addition, a well-documented but as yet insufficiently explained phenomenon is that lower inflation rates are also more stable. For this reason, the present context can be broadly described as one characterised by lower and more stable rates of inflation. The fact that in recent years many industrial countries have been enjoying a situation of low inflation rates, which can be characterised as one of price stability, is certainly a most important achievement that entails important economic benefits for society. Moreover, since inflation is, over the medium term, primarily a monetary phenomenon and since central banks are in charge of achieving and maintaining price stability, the present state of affairs is certainly much more comfortable for monetary policymakers than in the past, when they had to fight hard to bring inflation down. Nevertheless, contrary to those voices which have claimed in recent years that the task of monetary policy is now made less relevant, or even irrelevant, because ‘‘inflation is dead” and the ‘‘business cycle has disappeared”, the problems associated with deflation in Japan, on one hand, and the recent re-emergence of price pressures in the US and in the euro area in 2000 on the other, make it very clear that neither of the above assertions is correct. Indeed, living in an era of low inflation poses important challenges which monetary policy must address. Specifically, it must strive hard to maintain price stability by countering both inflationary and deflationary pressures, doing so in such a way as to ensure the best possible real economic performance. Monetary Policy Issues in a Low Inflation Environment*