The Benefits of Low Inflation: Taking Stock

This paper surveys the empirical literature on the benefits of low inflation, emphasizing contributions since 1990. It follows the framework of a section in the Bank's 1990 Annual Report, "The benefits of price stability." This framework looks at the costs of inflation, or the benefits of price stability, in the context of four themes: inflation creates uncertainty about the future; there are costs of having to cope with inflation; inflation affects equity and fairness; and `living with inflation' is no answer.

In this survey, the section on each theme begins with a brief summary of the points raised in the article in the 1990 Annual Report. The empirical literature, including surveys, is then reviewed extensively enough to establish a context. This is followed by a discussion of those benefits of low inflation that have been well quantified in the relevant literature and those that have not; how the literature on this issue has advanced since 1990; and what areas might benefit most from more research in the future.

Overall, the empirical evidence on the nature of the relationship among inflation, inflation uncertainty, relative price variability, and output has made substantial progress since 1990. Although a consensus view cannot be said to exist on the basis of this survey, there are indications (especially in the work that allows for the interaction of inflation, money balances, and the tax system) that the gross benefits of low inflation are larger than thought at the beginning of the 1990s.

The papers surveyed here imply that the choice of an optimal inflation rate for monetary policy depends on (i) how well papers showing sizeable benefits stand up in future research; and (ii) the results of ongoing research on the magnitude and persistence of various costs.