2.6 The Costs of Inflation

Curiosity 2.4: What Level of Inflation Should We Aim For?
In the early 1990s Governor John Crow of the Bank of Canada aimed for zero percent inflation. Most economists felt that this target was extreme; so did the Canadian government, which did not reappoint crow. Alan Greenspan, chairman of the Board of Governors of the Federal Reserve System, the U.S. central bank, offered a more flexible target in a statement to the U.S. Committee on Banking, Housing and Urban Affairs in February 1989:
Maximum sustainable economic growth over time is the U.S. Federal Reserve's ultimate objective. The primary role of monetary policy in the pursuit of this goal is to foster price stability. For all practical purposes, price stability means that expected changes in the average price level are small enough and gradual enough that they do not materially enter business and household financial decisions.
He did not make the mistake of aiming for an unrealistic level that in any event is inappropriate, nor did he pin himself down to a specific level, the better to deal with criticism. An inflation rate of 2 or 3 percent seems to be an acceptable target.

Media Illustrations
Example 1
The oil crisis caused U.S. oil companies' overseas profits to shoot up, producing a jump in ______________ that could mislead policy-makers.
Should the blank be filled in with GDP or GNP?
Income produced by Americans outside the geographic boundaries of the United States, such as overseas oil profits, is counted in GNP but not in GDP, so the blank should be filled in with GNP.
Explain why it could mislead policymakers.
One of the reasons the United States switched from GNP to GDP as its measure of output is that GNP movements can arise for reasons unconnected with domestic economic activity, as this example illustrates. Using GNP, policymakers may be misled into thinking that the U.S. economy is thriving, and as a consequence may undertake inappropriate policy action.
Example 2
Suppose, to use a not-unrealistic example, a new computer is invented that costs one-quarter the price of existing computers and performs as well. Now when GDP is calculated, production of the same number of computers creates only one-quarter as much dollar output GDP falls!

 



Macroeconomic Essentials. Understanding Economics in the News 2000
Macroeconomic Essentials - 2nd Edition: Understanding Economics in the News
ISBN: 0262611503
EAN: 2147483647
Year: 2004
Pages: 152

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