President's Message: Is 3 Percent Inflation Still Too High?

Thomas C. Melzer

As a public speaker, I've never been keenly accomplished at eliciting a good laugh from the audience. Several months ago, however, I stumbled onto a sure-fire laugh line in a speech I gave in St. Louis. Here it is: "The current trend rate of inflation remains stubbornly high at 3 percent."

Not exactly Rodney Dangerfield, I know. But to those who remember the disastrous, double-digit inflation rates of the 1970s, that characterization can be somewhat amusing. What the amusement reflects is the startling contrast between the variable and rising inflation of two decades ago, which caused uncertainty and speculative behavior that made it nearly impossible to maintain long-run growth, and the inflation rate of today, which is remarkably low and stable.

Indeed, for four years now, the annual rate of CPI inflation has remained at 3 percent or lower, and most forecasters project a similar outcome again this year. Looking further down the road, however, it is clear that few people expect additional improvement in inflation trends. A recent survey conducted by the University of Michigan Research Center found that most households expect inflation to exceed 3 percent well into the next century.

Some of you may recall that inflation was about 4 percent when, in what was regarded as a time of crisis, President Nixon imposed wage and price controls in 1971. Thus, a little over a generation ago, modest, single-digit inflation was understood to be unnecessary and undesirable. We should be no more indifferent to the dangers of inflation today than we were then.

The unfortunate fact is, inflation—even at low levels—erodes purchasing power. Since the beginning of the decade, for example, relatively low inflation has already reduced the purchasing power of the dollar by almost 20 percent. Keep inflation growing at a 3 percent rate, and in a single generation a dollar will buy only half of what it can today!

I do not want to detract from the impressive record of the past few years. In a very short period, we have witnessed the remarkable concurrence of several positive economic conditions: strong investment; moderate, balanced growth; and low, steady inflation. But as long as households and businesses are forced to take the inflation rate into account before they make economic decisions, inflation is still too high. We must not be complacent in our resolve to bring it down. For it is only in an environment free from inflation and inflation expectations that our economy can achieve its maximum potential.


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