Zero is not the optimal rate of inflation
Monetary policy and interest rates remain at center stage of the economic policy debate. During the last recession, the question was how fast and how low the Federal Reserve should lower interest rates. Now that the unemployment rate has fallen to a twenty-three-year low of 4.7 percent, the question has quickly become how high the Fed should raise rates.
Many economists adhere to the notion of a "natural" rate of unemployment (discussed below), and this notion is driving much of the current debate. Federal Reserve Board chairman Alan Greenspan recently stated that the law of supply and demand has not been repealed, arguing that increased inflation is inevitable if the economy continues on its current course. Behind this reference lies a belief in a natural rate of unemployment, itself determined by supply and demand in the labor market.
Side by side with this belief, many economists (including most at the Fed) also claim that optimal monetary policy should aim for zero inflation. However, the claim that this is optimal is inconsistent with the theory of a natural rate of unemployment. In effect, there is an a slip between the cup of theory and the lip of policy. How are we to explain this incongruity, and what really is the optimal rate of inflation?
Competing Perspectives on the Inflation - Unemployment Trade-Off
1. NAIRU: All rates of inflation are equally optimal
The dominant economic paradigm, subscribed to by both the Fed and Wall Street, is the theory of the non-accelerating inflation rate of unemployment (NAIRU), alias the "natural" rate of unemployment. NAIRU theory maintains that if you try to push the unemployment rate below the natural rate, the result will be an increase in inflation but no permanent reduction in unemployment. This is because market forces push the economy back to the natural rate of unemployment, so that the only effect of sustained expansionary monetary policy is increased inflation. NAIRU theory, therefore, maintains that policy-makers cannot trade off a bit more inflation for a little less unemployment.
Economists label the relationship between inflation and unemployment the Phillips curve. According to NAIRU, the Phillips curve is vertical, as shown in Figure 1. Its verticality indicates that if the central bank (i.e., the Fed) increases inflation, there is no reduction in the unemployment rate. Similarly, lowering the inflation rate also has no effect on unemployment. This means that the inflation rate cannot be manipulated to lower unemployment.
The economic logic of natural rate theory is as follows: The level of employment is determined by the interaction of firms' demand for labor and workers' supply of labor. Because of imperfect information among workers regarding the location of jobs and imperfect information among firms as to who job seekers are, there is always a little unemployment resulting from some workers failing to hook up with potential employers. However, neither the demands and supplies of labor nor the pattern of information among firms and job seekers is affected by inflation. Consequently, inflation cannot affect the level of employment and unemployment, and hence the Phillips curve is vertical: Inflation simply has no effect on labor-market outcomes.
According to NAIRU theory, neither inflation nor deflation (negative inflation) has any effect on either unemployment or output. Thus, from a strict NAIRU perspective, all rates of inflation are equally optimal: Inflation simply does not matter. Although Wall Street and Federal Reserve economists may push for zero inflation, their own theoretical framework actually provides no justification for this policy stance. The implication is that they either do not understand the issue (which is unlikely) or that they are really working with some model other than NAIRU.
2. The optimal inflation rate is the actual rate
A modified version of NAIRU theory maintains that the optimal rate of inflation is the actual rate. Thus, if an economy currently has a 5-percent inflation rate, 5 percent is the optimal rate. The logic is that inflation itself does not matter, and in the long run the Phillips curve is vertical. However, lowering the equilibrium rate of inflation is costly and results in lost output.
The reason it is costly to lower inflation is that economic agents have inflation expectations, and these expectations are hard to adjust. Getting agents to lower their inflation expectations requires a period of higher unemployment, and this implies lost output. Thus, if the central bank wants to lower inflation from 5 to 3 percent, this would require a period of higher unemployment, and there would be an output cost. However, since there is no compensating benefit to reducing inflation, the implication is clear - the central bank should stick with the existing 5-percent rate.
A problem with this reasoning is that just as there is a onetime cost to lowering the rate of inflation, so too there is a onetime gain to increasing the rate of inflation. If the central bank stimulates the economy, employment and output will temporarily increase. After agents have adjusted their inflation expectations upward, the economy will then return to the vertical Phillips curve with a higher equilibrium rate of inflation. In the long run, unemployment and output will again be unchanged, but there would have been a one-time gain. Given this logic, the central bank should go on nudging the inflation rate ever upward, so that gradually accelerating inflation is the optimal policy.
3. Zero inflation is the optimal rate
Most economists adhere to NAIRU theory with its vertical Phillips curve. At the same time, many would also agree with the claim that zero inflation is the optimal rate of inflation. But these positions are inconsistent.
The claim that zero inflation is optimal implies a different model of inflation from that of NAIRU. According to NAIRU, inflation has neither costs nor benefits. However, if zero inflation is optimal, it must be the case that inflation is costly and causes lost output and increased unemployment, which is why zero inflation is preferred to non-zero inflation.
Implicit in this claim is a notion of a positively sloped Phillips curve, shown in Figure 2. Now, increased inflation causes a northeasterly movement along the Phillips curve that results in higher unemployment. The reason for this negative effect is that inflation distorts the decisions of agents by forcing them to waste resources combating its effects. As a result, profitability, output, and employment are all reduced. An analogous logic applies to deflation, which also induces agents to waste resources combating its effects. Given this, the Phillips curve is bow-shaped, and maximum productive employment is obtained at zero inflation. Zero inflation is therefore the optimal rate of inflation, since it saves households from wasting resources in combating the distortions of inflation.
4. The Keynesian Phillips curve
An alternative theory of inflation is the Keynesian Phillips curve. According to this theory, there is a negative long-run relationship between unemployment and inflation. This is illustrated in Figure 3, in which unemployment can be reduced at the expense of a little more inflation. The Phillips curve is convex, so that as the unemployment rate falls, the trade-off worsens: Further reductions in unemployment cost more and more in terms of inflation. The significance of this construction of the inflation-unemployment relationship is that the central bank now has a policy choice that involves trading off between inflation and unemployment.
The economic logic of the Keynesian Phillips curve is that "inflation greases the wheels of adjustment" in labor markets. In a dynamic multisector economy in which different sectors are subject to random shocks, there is a need to adjust sectoral prices and wages. In sectors receiving positive shocks, prices and wages are bid up; in sectors receiving negative shocks, there is a need for prices and wages to fall. However, it is difficult to get prices and wages to fall, and it may therefore be easier to accomplish adjustment by having prices rise in sectors with full employment. In this fashion, a little inflation can grease the wheels of adjustment, thereby lowering unemployment and raising output.
sumber : http://findarticles.com/p/articles/mi_m1093/is_n1_v41/ai_20485329/
* According to NAIRU theory, neither inflation nor deflation (negative inflation) has any effect on either unemployment or output
Meaning : Menurut teori NAIRU, baik inflasi maupun deflasi (inflasi negatif) memiliki efek pada baik pengangguran atau output.
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