Implications of Uncertainty about Long-Run Inflation and the Price Level

This paper surveys recent developments in the theoretical and empirical literature on the economic implications of uncertainty about the longer-term outlook for inflation. In particular, the linkages between inflation, long-run inflation uncertainty, and aggregate economic activity in industrial economies have become considerably better understood during the past decade. In the case of Canada, there is evidence that uncertainty about long-run inflation fell considerably between the high-inflation period of the 1970s and early 1980s and the subsequent moderate-inflation period, and decreased still further in the low-inflation period that has been evident since the early 1990s. As a result, both businesses and households have increasingly used longer-term financial instruments to meet their financing needs over the past two decades. In general, recent empirical work for Canada and elsewhere considerably strengthens the view that reductions in long-run inflation uncertainty can have beneficial effects on financial markets, capital spending, and ultimately aggregate levels of economic activity. Recent theoretical developments have improved our understanding of why this is so.