Understanding Lowflation

Andolfatto, David; Spewak, Andrew

doi:10.20955/r.101.1-26

Journal Article

Understanding Lowflation

Abstract: Central banks are viewed as having a demonstrated ability to lower long-run inflation. Since the Financial Crisis, however, the central banks in some jurisdictions seem almost powerless to accomplish the opposite. In this article, we offer an explanation for why this may be the case. Because central banks have limited instruments, long-run inflation is ultimately determined by fiscal policy. Central bank control of long-run inflation therefore ultimately hinges on its ability to gain fiscal compliance with its objectives. This ability is shown to be inherently easier for a central bank determined to lower inflation than for a central bank determined to accomplish the opposite. Among other things, the analysis here suggests that for the central banks of advanced economies, any stated inflation target is more credibly viewed as a ceiling.

JEL Classification: E31; E52; E58; E62; E63;

https://doi.org/10.20955/r.101.1-26