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President's Message: A Low Inflation Policy Is a Pro-Growth Policy


Thomas C. Melzer
Friday, July 1, 1994

Over the years, the Federal Reserve has often been accused of paying too much attention to inflation. Indeed, we're hearing that charge today, as critics worry about a continuation of Federal Reserve moves last spring to pursue a less accommodative monetary policy. In its zeal to keep inflation low, critics say, the Fed is stifling economic growth.

Unfortunately, what such criticism implies is that, when the Fed pays attention to inflation, it disregards economic growth. In fact, quite the opposite is true.

Many developed countries have attempted to run higher inflation policies in the name of economic growth since World War II. They do this by consistently keeping short-term interest rates low, which fosters relatively high monetary growth rates over time. The evidence shows, however, that these economies grow no faster than countries that pursue relatively low inflation policies.

The same holds true for developing countries. A recent study at MIT, which considers the effects of inflation policy on economic growth in Latin America, Asia and Africa, looked at countries from across these continents and found that those with relatively high average inflation rates tended to grow more slowly than those closer to price stability, even after taking account of other factors that can influence the economy.

When it comes down to it, fostering inflation in the hope of more rapid economic growth is like chasing a mirage through the desert. You can travel a long distance, under harsh conditions, and end up with no water. Similarly, we can endure higher inflation rates for a long period of time and end up with no additional economic growth.

A low inflation policy, of course, is not an end in itself. The Fed seeks a stable, low inflation environment for a very pragmatic reason: relatively steady prices contribute to better economic decision-making.

In my opinion, the main contribution the Fed can make to the economy in the long run is to keep inflation low and inflation uncertainty to a minimum. This means maintaining a consistent policy over a long period of time with a credible commitment to low inflation. In this way, monetary policy can provide a stable price backdrop that will enable the nation to achieve the maximum sustainable rate of economic growth. That is a pro-growth policy, and one that I think the Federal Reserve should continue to pursue.

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