Wages and Panic Buttons

Seth Ackerman SAckerman at FAIR.org
Wed Aug 4 10:24:37 PDT 1999

Doug wrote:
> >While inflation means higher nominal interest rates,
> >it generally means lower real (minus inflation) interest
> >rates, because (1) existing contracts can't be rewritten,
> >so lenders locked into 7% are stuck, whatever the inflation
> >rate; and (2) since inflation is associated with rapid growth
> >and high demand, competition between lenders keeps
> >nominal interest rates from rising too fast.
> Does it really? I thought there was a lot of recent research showing
> essentially no relation between inflation and growth if you leave out
> the rare instances of hyperinflation (which is usually a symptom of a
> society in collapse).

From Joseph Stiglitz' 1998 World Institute for Development Economics Research lecture:


<Probably the most important policy prescription of the stabilization packages promoted by the Washington consensus was controlling inflation. The argument for aggressive, preemptive strikes against inflation is based on three premises. The most fundamental is that inflation is costly and should therefore be averted or lowered. The second premise is that once inflation starts to rise it has a tendency to accelerate out of control. This belief provides a strong motivation for preemptive strikes against inflation, with the risk of an increase in inflation being weighed far more heavily than the risk of adverse effects on output and unemployment. The third premise is that increases in inflation are very costly to reverse. This line of thought implies that even if maintaining low unemployment were valued more highly than maintaining low inflation, steps would still be taken to keep inflation from increasing today in order to avoid having to induce large recessions to bring the inflation rate down later on. All three of these premises can be tested empirically.

I have discussed this evidence in more detail elsewhere (Stiglitz 1997a). Here I would like to summarize it briefly. The evidence has shown only that high inflation is costly. Bruno and Easterly (1996) found that when countries cross the threshold of 40 per cent annual inflation, they fall into a high-inflation/low-growth trap. Below that level, however, there is little evidence that inflation is costly. Barro (1997) and Fischer (1993) also confirm that high inflation is, on average, deleterious for growth, but they, too, fail to find any evidence that low levels of inflation are costly. Fischer finds the same results for the variability of inflation. Recent research by Akerlof, Dickens, and Perry (1996) suggests that low levels of inflation may even improve economic performance relative to what it would have been with zero inflation.

The evidence on the accelerationist hypothesis (also known as 'letting the genie out of the bottle', the 'slippery slope,' or the 'precipice theory') is unambiguous: there is no indication that the increase in the inflation rate is related to past increases in inflation. Evidence on reversing inflation suggests that the Phillips curve may be concave and that the costs of reducing inflation may thus be smaller than the benefits incurred when inflation is rising.

In my view, the conclusion to be drawn from this research is that controlling high and medium-rate inflation should be a fundamental policy priority but that pushing low inflation even lower is not likely to significantly improve the functioning of markets.>

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