Considerations on inflation, economic growth, and the 2 per cent inflation target

This paper considers two basic questions with respect to inflation control, inflation targeting, and overall macroeconomic performance. The initial question is: what has been the justification in research for establishing an inflation target, and specifically a low inflation rate target of 2–3 per cent, as the organizing principle and overarching goal of macroeconomic policy? The second question is: do we actually observe stronger macroeconomic performances – as measured in standard terms of gross domestic product (GDP) growth – when macro policy operates within the framework of such low inflation targets? Our answers to these questions are straightforward. First, no serious body of research has been produced that provides a clear justification for a 2–3 per cent inflation target as the central goal of macroeconomic policy. Further, there is no body of evidence showing that economies at any level of development consistently experience stronger economic growth outcomes when inflation is maintained at less than 3 per cent as opposed to higher inflation rates, certainly within a 4–5 per cent inflation range and, in some circumstances, somewhat higher rates still. These findings are significant insofar as they open space for considering the set of measures other than contractionary monetary policies as viable inflation control tools. It is possible that these other measures do not operate as forcefully as contractionary monetary policy in bringing inflation down to a 2–3 per cent target range. However, our findings suggest that it is not typically necessary to force down inflation to such low levels, especially given that contractionary monetary policies succeed in controlling inflation primarily through the channel of raising mass unemployment and weakening workers’ bargaining power.