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.-
FRB: CLEVELAND.
_HOSKINS.
ADDRESSES.
//10.
For rel ease on de I i very
5:00 p.m., E.S.T.
January 26, l9B9
H01'¡
T0 ACHIEVE ZERO INFLATION: GOING oN A MoNtTARy DIET
l,¡. Lee Hoski ns, pres i dent
The Federal Reserve Bank of Cleveland
JAN
1O
]:O^;
L$RARY
San Francisco Association of Buslness Economists
san Franc i s cT,u,,ì,ri,rnor. t .
How Èo Achieve Zero
rnfration:
Going on a r{onetary Diet
Introduction
r wourd like co talk with you Eoday about why we as a nation should
adopt
a goal of eliminating inflation completely. The benefits of
reducing
inflation Eo zeto would be substantial, perhaps as substantial
as those we
have already enjoyed in reducing inflaËion from 12 percent to
4 percent.
r
believe that a pre-announced program Eo eliminate inflation graduarry
ovet a 4
to 5 year period would further enhance economic performance. The Federal
Reserve arone has the ability
recommend
co control the inflation
rate,
r wourd like to
several changes in the policy process that would make this goal
easier to achieve.
My remarks today should not be incerpreted in Ehe context
of today,s or
tomorrow's monetary polÍcy,
As you know, the Federal Reserve, confronted wich
a steP-up in infrationary Pressures lasE year, moved gradually on
several
occasions toward a more resËricEive monetary polÍcy. over the past
year short-Eerm interest rates have risen by 2 r/2 to 3 percentage
points,
and the grov¡th of each of the principal monetary aggr.egates
which we watch
has
slowed significanËly.
changes in recent years in the relationships becween policy
instruments
and ultimate objectives as well as the long and variable lags
becween monetary
poricy actions and inflation
mean thaÈ we cannoc
be sure of the effects of
last year's monetary actions. rn similar fashion, we cannot make or modify
monetary policy today without exercising large elements of judgment.
AIEhough
we
will noÈ knor¡' the ulEimate outcome for
some
time, our actÍons last year
may
have prevented a further acceleraËion in che inflation
inclined Eo doubc that we have
made much
rate.
But I
am
scÍIl
progress toward an inflation_free
environmenE.
Inflation,
as I
to eliminate inflation,
reducing inflation
is
for some time, is too high. Although we seek
do noc seek to do so abruptly. Nevertheless,
have argued
we
such
an important goal Chat policymakers should
willing to err on the sÍde of overly-restricEive policies, uncil
it
clear that progress toward that goal is beÍng made.
be
becomes
A l{onetary Diet
disagree that price stability is good policy. unforrunarely,
zero inflation is easíer to advocate than achieve. I^Ihy is it so
hard to end
Few would
inflaÈion? consider for a moment an analogy
between a monetary
poricy to
eliminate inflation and a personal program to eliminate excess weight.
rn
both cases giving advice is easy. rc is easy to say eat less and
you
wirl
lose weighE' Likewise, it is easy to recognize that the Federal
Reserve
the abiliÈy to end Ínfration and must srow money growth Eo do so.
Anyone who has
tried to lose weight
knows
that
good intenEions do
guarantee the desired outcome. once a weight-loss program
always be temptations
pass
up,
Ehe
to
noE
begun Ehere
it.
rf a particular meal is just
that he wirl make ic up tomorro$r.
abandon
dieter promÍses
is
has
wiIl
Eoo good to
is fulr of quick-fix programs that promise easy, overnight
weÍght-loss, yet rarely deliver on such promises. tleight-loss programs
thac
The market
don't r¡ork are probably worse than none at all.
from a permanent reduction
in weighÈ.
The
health advan¡ages
Programs EhaE reduce Èoo
come
qulckly, only
temporarily, or fail co provide adequate nuErition are health hazards and
ought to be avoided.
3
successful weight-loss Programs share some conmon elements. They begin
by seEting realistic goals whích are well-defined and measurable. A good
dieE
plan begins with an explicit goal, a long-term deslred weight level,
and a
time frame for reaching the goal ' The successful plan connects a program
for
daily behavior to the rong-term goal. The program also includes
a dairy menu,
supprying the nutrients needed ro keep rhe body hearrhy, bur rimiring
rhe
daily intake of calories.
A good program will also include some exercise and
health monitoríng. The successful program outllnes what you shourd do
today,
right now, and in every period unËil the goar is achieved.
In many vtays' our desire to end inflaËfon is like an individual,s desire
to lose weight. As of today, there is no outside authority that lrirr
make us
cornmit to long-run price stability.
once the program for ending inflation
begun' we may quit at any time and return to an inflationary policy.
will belteve that our dislnflation
has
No one
policy wl11 really lead Eo zero inflation
unless we state well-defined objectives and allow people to see that
our daily
acÈions are consisEent wfth our 1ong_term goals.
Many ask why we should seek
zero inflation.
I think the diet analogy is
a good one' Just as excess body fat reduces mental and physical performance
and leads to other health problems, inflation reduces the effÍciency
of
markets and leads
to other
economic problems.
others question whether zero inflatÍon is a realistic or polltÍcally
feasible goar. Quite frankry, r,m not sure, but part of my responsibirity
a central banker is to parcicipate in establÍshing poricfes ËhaE are
considered feasible and realistlc. other countries have succeeded.
Two of
our major trading partners, I.Iest Germany and Japan, are prosperlng under
as
4
poricÍes of price stabirity.
economic performance during
inflation environment.
Furthermore,
r think che improvemenc in
the last six years
owes much Eo
Ehe
u.s.
the lower
not have scabre prices yeE, buE rike a dieEer
who has begun to lose weight' we are already performíng
at a higher level.
several factors seem to stand in the way of an expliciE commitment
I,le do
to end
infratíon' First, there is the misEaken idea that we know the actuar
lever of
fulI emplo)rmenË or the maximum feasible noninflatÍonary growth path
for che
real economy' second, there is the misÈaken idea that the Fed can
engineer an
increase in real output if the economy begins to falr below
Ehe trend growth
rate' rf there are short-term benefits from such a policy, and r
do not think
there are, they will be temporary and r.¡ill surely be followed
by ronger-term
cosEs disproportionate to the gains. Think about the
droughc in lggg for a
moment' could the Fed have replaced the losÈ food by manlpulatlng
interesÈ
rates or inflation?
certainly, r do not believe that qre can make peopre better off by
manipulating the inflation rate Ín an attempt Èo smooth rear
GNp growth.
I^/e
are not better off if suppliers mísread an inflationary policy
for a real
increase in demand. To the extent that business cycles spring
frorn real
shocks and imbalances in the economy, we will have downturns
that are not the
fault of
monetary
pollcy. rf
Ehe Federal Reserve takes
responsibilfty for
the
business cycle rather than inflation, a comnitment to an
ÍnflaEion-free
environment will not be credible. lfhile there may be temporary
adJustmenË
costs to ending inflation, these cosËs can be reduced. Moreover,
there
permanent 10sses in welfare from an inflatl0nary
environment.
are
rf lnflation is allowed co continue, the potential of the economy wirl
be
reduced' rE is imPortanÈ to recognize thaE the dlsrupEion Èo rear
ougput from
5
moving
to
end inflaEion
will be greater if
we alrow
inflation to rise or if
we
Iose credibiliry.
is another objection to a zero inflation policy. Many who would
otherwíse agree to a policy of price scability argue that
a little inflation
is good because economic efficiency requires flexibility in rear
There
wages and
nominal v/ages are
rigid downward.
I,Iorkers are psychologically adverse to
declines in nomÍnal wages ' The argwnent is chat inflation lubricates
the wage
adjustment process by allowing real \¡rages to be adJusted downward
in response
to Índustry-wide
shocks wichout confronting workers
with
Ehe need
for expricit
cuts in pay' rnflation diffuses che blame, and somehow workers
don,E
as
mind
much.
r don't like this argumenÈ because it assumes workers are ignorant
or
irrational. Economists make this argumenÈ based, not on theoretical
consideratíons, but on how they think the real world differs
from their
theories. They fail to understand chat this behavior is due Èo ongoing
inflation'
Rather than help lubricate Ehe wage adjustment process,
inflation complicates
by inflation'
standard
and bogs down the
process.
They know they need wage increases
of living. But the
economy performs
I+rorkers
r think
of¡en feer cheated
just to main¡ain a given
less efflciently with inflation
and workers are
less producEive, often through no faulE of their own.
rn a world of zeto inflation, workers would not have to look through the
veil of inflation co see how they were being compensated. l.Iorkers courd
more easlly see Èhat wage increases r¡¡ere rerÀrards for permanent
increases in
productivity.
6
Choosing a Gradual path
The ultimace goal
is an inflation free environmenE, but the policy to get
there should be gradual. A person who is 50 pounds overweight
shourd not try
to lose 50 pounds immediately. Iy'hen an economy has experienced
inflacion for
some time people develop inscftutions and behavior
patterns Ehat help them
cope with inflation. I^Ie get used to high nominal
interest rates. I.Ie
come to
expect ínflation to reduce real debt burdens. Expectations
of infracion
become embedded in asset prices. The ,,dieEing,,
economy shourd not atÈempt
to
eliminate inflacion immediately.
Poricymakers have long worried
that if they try to stop inflatfon, rhey
might start a Process of declÍne and deflation that cannot
be stopped. ,oe
have had experiences in which disinflation led to
severe declínes. The worst
of these ínsËances occurred because of conËractions fn the volume
of money and
credit. certainry, we can be encouraged by the way the Federal
Reserve
liquidity in the economy following the ocrober 1gg7 stock markec
crash, without abandonÍng longer_term pollcy goals.
In any case' I chlnk we induce unnecessary costs in the economy
if we try
maintained
co eliminate
inflatfon too quickly.
Any tlme the
lnflation rete Ëurns out to
be different than expected there are arbitrary redistributions
of income.
rmagine what would happen if the Fed went to zero
inflaËion imrnediately. The
people who had purchased Treasury debt
in recenc years would reap a windfall
as market rates fe11 with lower inflation expectations.
The taxpayer wourd
bear the real burden. The average maturity on Treasury debt
is just a few
years, so it
to take a few years to ellmlnate inflation.
Each of the reasons why we mighc go faster or srower
shourd be the
subject of more research. I.Itrile r have suggested one percentage
polnt per
makes sense
7
yeat
,
perhaps other PaEhs \'/ourd be
preferable. r am not so concerned about
the exact timing of disinflation as r am about committing
to a specific path
so that the "weight-waÈchers" "Fed-watchers,, in this
case -_ can monitor
our progress and feel confident that the policy is sound.
Recent events in the financiar markets cer.ainly suggest
growÍng
in the cornmitment of the Federal Reserve to a less inflationary
future. But it is worth remembering thaÈ a cenEral bank that loses
confidence
credibility
not have Èhe ruxury of adopting a gradual poliey. This is
most obvious in cases of hyperinflation where the entire
monetary systen musE
rnay
be reformed overníght. rn moderace inflations as we have
Ín the united states
today, I think a gradual policy will work.
Choosine
a Soecific Index
Another
practical
is deciding which price index shourd be used as
Èhe officfal targec of policy. should we use an
index of products consumed,
like the consumer Price rndex, an index of goods produced, like
the producer
Price rndex, a subset of these, or a general index lÍke the GNp
deflator.
Again, there
problem
may be many reasons Eo choose one
index or another. over the
longer run, r don't think ic matters as long as we choose a general
price
index which wourd tend to reflect Èhe prÍce of things produced
and purchased
using
U.
S. dollars.
However' once we decide Eo imprement such a
target that has
poricy,
we wourd
prefer
a
desirable short-run properties. rt should not be too
sensitive in the near term to supply shocks and foreign evenEs.
An index,
like the
sorne
Price rndex, often deviaÈes from its underlying trend for as
much as a year or tvro because of changes in the price
of imporÈs, or because
of a supply shock rike the drought we had last surnmer. on the other
consumer
hand, if
8
the CPI was chosen
as Ehe
allow deviaEions from
Ehe
Earget, there is no reason why Che Fed could not
cargeE paEh if chere was a clear reason for
doing
so,
Many people have argued Èhat
current price indexes overstate the true
inflation rate by L to 2 Percent because the price rndexes
do noc cap.ure the
qualÍty increases Ín new products. This is a technical
issue and
like
díeter
who has an inaccurate
allowances
for the
l{aklng the policy
scale, r would either get a new one or
a
make
inaccuracy.
Work
over the Past several years the Federal Reserve has gradually
reduced
the growth of che various measures of the money supply.
rt seems to me that
the disinflacion Process wlll require further gradual reductions
ln the growth
of the money supply and the monetary base. The growth of che
base has
been
reduced from almosE 10 PercenË
in
to 7 percent rast year. From time to
time some have criticized Èhe unevenness of the reductÍon;
but continued
progress Èoward zero Ínfration, requlres a continued
gradual reductlon in the
groïrth of the base and the other monetary eggregetes.
1986
Providing Infomation
The increased uncertainty about
velocity and the relaËionships
between
the monetaty ag,gtegaces and economíc activíty in the 1gg0s
has reduced the
usefurness of the Ínformation available to the publlc
about monetary poricy.
io monltor policy
now, peopre must
rely on reports of fnflatlon which are
influenced by non-monetary factors and may lag well behfnd
policy changes. No
9
one knovts for sure the connection between
the dieter,
policy actions and infration. Like
'e can onry begin a program, use our best judgment, and make
adjustments as lre go along.
As long as
to use judgment, there wirl be some skepticlsm. The
best way Èo overcome Ehis doubt is to provide the mosE
compleÈe picture of
polÍcy to the public. currenEly, under the Full EmproymenÈ
and Balanced
r¡te
have
Act of l-978 (Humphrey-Hawkins), the Federal Reserve is required
to
regularly and publicly discuss lts view of currenc economic
condftlons and its
predicclons for economic growth, infraÈion and unemproyment.
Moreover, the
Growth
Federal Reserve
is required to report its obJectives for various moneËary
aggregates ' The basic purPose of thís law
is co clarify policy actions and
ensure that they are consistenE with longer_run goals.
Aside from Humphrey'Hawkins testimonÍes, the Federal
Reser:¿e regurarly
releases some information (Policy Directives) about each
FoMC meetÍng six or
seven weeks after the meetrng. The polfcy Direccive
contains a brief
discussion of how the FOMC has voted to change poricy
in
of ÍndÍvidual
some
way.
The votes
committee rnernbers are provided.
is mlssing is a clear message relattng these short_term poricy
actions to an inflation goal. r am interested in providing
more comprete
Ínformation' The Pollcy Dlrective may inform che publlc that
L'hat
rhe Federal
to tighten or roosen, but the public canno¡ terl by how
much, for how long, or to whaÈ end. under current
procedures, the Federal
Reserve has chosen
Reserve announces discounÈ
rate
changes imrnedlately, and
it usually gives a
brief discussion of why the change was made. A sinirar procedure
for arl
pollcy actions would seem desirable.
10
Conclusion
rf r
were overweight and had promised my doctor
for years that r
wourd
lose weighE, he wourd be undersÈandably skeptical
about announcemencs of a ner,/
diet plan. However, íf r tord hÍm rhat r had restricted
my diet to 2,ooo
cal0ries per day for the last month and had 10st four pounds,
that r felt
better than ever, and that r intended to continue until
r lost
50 pounds, then
he mighÈ believe
me' rf he had a large stake in my future health, however,
he
would continue to monftor my weight to make sure
r was staying on the plan.
Likewise, we could adopc a program to end inflation that
would be
credible if peopre saw it working' The plan should
invorve a steady diet, not
bouts of starvatlon followed by binges. Ilhile it
might not be painless in
che begÍnning, the cost would be reduced if we
ret people see how we pranned
our menus and lf we let Ehem watch us eat our meals.
Furthermore, once
infration-free
an
is achieved, maintaining it will not require
sacrifice on the part of Ehe pubric. on the contrary,
r thlnk much of the
recent preasant surprise in our economic performance
is due to recent success
in lowering inflation. Like the successful dieter, Èhe
environment
economy would perform
even
better if
r^re
were
to achleve an inflatl0n-free
envlronmenc.
@FedFRASER