n, may show a higher degree of sensitivity to inflation than those with lower ‘moderate’ inflation. For example, as noted above, most of the industrialised countries in recent years have inflation targets ranging between two to three per cent. But, among the developing countries, some of the fast growing East-Asian economies have not only demonstrated low inflation rates ranging between three to five per cent, but the growth rate at these inflation rates has been fairly high at around eight per cent. Empirical evidence on the relationship between the inflation and growth in cross-country framework is therefore somewhat confusing. Several studies make it clear that the negative impact of inflation on growth is more severe at unmistakably high rates of inflation, there is no consensus about the threshold inflation rate beyond which, or under which, the negative impacts of price stability become pronounced. The term ‘moderate’ or ‘low’ inflation is clearly relative and dependant upon a number of circumstances. In part, this fact also obscures the analysis of policies that seek zero inflation, or virtual price stability. The effects of virtual price stabilityMost policy makers generally worry about inflation, however moderate, because if not held in check, a little inflation can lead to higher inflation and ultimately affect growth. Several central banks believe that the “economic benefits of reducing inflation, say, from 4 per cent to 2 per cent, are ‘many and large’ and the unemployment costs are ‘transitory and small’ by comparison.” This perception rests on the Friedman’s “classical idea that the Phillips trade-off between inflation and unemployment disappears in the long run, and even in the short run if the central bank’s commitment to zero inflation is made credible and has a direct downward effect on expected and actual inflation that m...
