Comment on Bennett T. McCallum’s Should Central Banks Raise their Inflation Targets?

McCallum’s answers his question by saying that raising this target is a “sophisticated but predominantly bad idea” and the paper gives eight reasons for this conclusion. The first is that inflation is a particularly distortionary tax. The second is that, with sticky prices, inflation can lead to inefficient changes in relative prices. The third is that, based on the analysis of Schmitt-Grohé and Uribe (2010), even a somewhat negative target inflation rate allows interest rates to be set optimally while avoiding the zero lower bound (ZLB) most of the time. The fourth is that, even when the ZLB is hit, interventions in long term bond markets and foreign exchange markets should be quite helpful in stabilizing output. Fifth, McCallum suggests that an attractive change in institutions, namely the abolition of currency, would allow the central bank to set negative rates and thereby dispense with the ZLB. Sixth, McCallum notes that the admission that raising the average inflation rate would limit ZLB problems would be tantamount to accepting that there is a long run tradeoff between inflation and unemployment. McCallum fears that recognizing this would reduce central bank independence and thereby raise inflation too much. Seventh, McCallum notes that an average inflation rate of 4% since 1792 would have resulted in a substantially higher level of prices at present. This echoes one of the arguments against inflation articulated by Summers (1991), namely that high inflation erodes the dollar as a standard of measurement. Lastly, McCallum expresses the fear that inflation would lead the government to engage in additional deficit finance, which he regards with dismay. ∗Professor of Business Administration, Harvard Business School, [email protected]. I wish to thank Robin Greenwood for discussions.