Can Monetary Policy Make a Difference for Economic Growth and Inequality?

The basis for central bank policy aimed at price stability is the view that the benefits from very low inflation are "large and permanent," and that the related unemployment costs are "small and temporary." I question this belief in three ways: first, I point out that the quantitative evidence of large direct macroeconomic benefits from very low inflation is flimsy. Second, I show that the traditional inflation-unemployment tradeoff, which leaves no room for a permanent effect of monetary policy on output and employment, is a total failure as a description of the Canadian experience of the past decade. Third, I report on new evidence which shows that holding inflation below 2 percent (as the Bank of Canada has done since 1991) increases unemployment substantially and permanently, but that pushing inflation above 4 percent also generates higher permanent unemployment. Consequently, the optimal, unemployment-minimizing rate of inflation would be neither less than 2 percent nor greater than 4 percent, but would lie somewhere in between. I conclude that what is called for at this time is a monetary policy that is opportunistic on the expansionary side and brings the inflation rate into this range. Since poverty and unemployment are highly correlated, this new approach could also reduce poverty in Canada.