They are not sure whether
to attribute the surging prices to a real spurt in demand, to
speculation, inflation, or what. They often make the wrong decisions.
They postpone investments - or over-invest and embark on preemptive
buying sprees. As Erica Groshen and Mark Schweitzer have demonstrated
in an NBER working paper titled "Identifying inflation's grease and
sand effects in the labour market", employers - unable to predict
tomorrow's wages - hire less.
Still, the late preeminent economist James Tobin went as far as calling
inflation "the grease on the wheels of the economy". What rate of
inflation is desirable? The answer is: it depends on whom you ask. The
European Central Bank maintains an annual target of 2 percent. Other
central banks - the Bank of England, for instance - proffer an
"inflation band" of between 1.5 and 2.5 percent. The Fed has been known
to tolerate inflation rates of 3-4 percent.
These disparities among essentially similar economies reflect pervasive
disagreements over what is being quantified by the rate of inflation
and when and how it should be managed.
The sin committed by most central banks is their lack of symmetry. They
signal visceral aversion to inflation - but ignore the risk of
deflation altogether.
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