oeconomic Policy in a World Economy, Stanford economist John Taylor argues that the reductions in output necessary to achieve zero inflation are smaller than suggested by traditional models. The problem with traditional estimates, writes Taylor, is their failure to account for the effects of credibility gaps in past disinflations by the Federal Reserve. Harvard economist Martin Feldstein argues that the costs of a disinflation from 2 percent to zero percent inflation would be far outweighed by the long-term benefits. These arise, Feldstein argues, because even low rates of inflation exacerbate the biases in favor of current consumption and owner-occupied housing created by our tax system. Others claim that zero inflation has costs of its own. A recent Brookings Institution paper by George Akerlof, William Dickens, and George Perry argues that moderate inflation yields significant efficiency gains by "greasing" the wheels of the labor market. Firms use inflation to "cover" adjustments in real wages and at zero inflation nominal wage cuts, never popular among workers, would necessarily be more common. The difficulty of adjusting real wages in the absence of moderate inflation has cumulative negative effects, they claim, including permanently higher unemployment and lost output. This argument, while interesting, is nevertheless controversial and evidence from labor market studies by David Card, Dean Hyslop, and others does not confirm the potential for such clear efficiency gains from the presence of moderate inflation. Another argument against zero inflation is the risk of deflation, a drop in ...
