eriment for much longer. Abandoning the policy, however, would also be very costly in that, by undermining confidence in the authorities’ capability and determination, it would make it almost impossible for the Bank’s future policies to have beneficial direct effects on expectations. The alternative strategy of defining a target path for unemployment, though liable to be condemned by the public as ‘cold-blooded’, might minimise this risk and thus lower the expected unemployment cost of the ultimate reduction of inflation. But, this too may prove to be different in practice.Empirical studies have shown that, contrary to the prevailing beliefs of many economists and central bankers, in the “long run, a moderate steady rate of inflation permits maximum employment and output. Maintenance of zero inflation measurably increases the sustainable unemployment rate and correspondingly reduces the level of output.” Zero inflation inflicts permanent real costs that are much larger than envisaged by present-day policy makers. Following Canada’s path to zero inflation, empirical modelling demonstrates that the instigation of a policy of zero inflation immediately reduces employment, and it continues to decrease until the third year of the zero inflation ‘experiment’. “The effects of wage rigidity mount as inflation approaches zero, increasing the incremental unemployment cost of reducing inflation further. The zero inflation rate target is not reached until the 6th year, at which point unemployment has reached 10.8 percent. Unemployment declines gradually from that point, nearing its steady state rate of 8.4 percent after a decade.” Without much surprise, this does very closely reflect the effects of the zero inflation monetary policy pursued in Canada. Policy makers should not be satisfied with an ultimate unemployment rate of 8.4%. Not only is this rate of unemployment still ...
