Thor Koeppl, Professor of Economics and RBC Fellow at Queen’s University, argues that the Bank of Canada should return to its inflation-targeting roots. He notes that the current two per cent target was initially an interim goal, and that the original objective was price stability: zero inflation. If the inflation target is to be changed, it should be with a bias towards lower inflation.
Koeppl’s argument is built around the well-known arguments for why inflation is costly. The Friedman Rule says that the private cost of holding an extra dollar (that is, the nominal interest rate) should be equal to the social cost of adding an extra dollar to the financial system (that is, zero). If the optimal nominal interest rate is zero, and if the nominal interest rate is equal to the real interest rate plus expected inflation (the Fisher Equation), then the optimal inflation rate is negative. In such a world, the purchasing power of money would increase over time at the real rate of interest, just like any other asset.
Bill Robson's discussion endorses the general thrust of Koeppl's thesis, arguing that the risks associated with hitting the effective lower bound for interest rates are manageable. More fundamentally, Robson argues that people view money as a unit of measurement, and that they prefer its value to remain constant, much in the same way that people prefer the units of measurement for weight, volume and temperature to stay constant.
Thor Koeppl and Bill Robson take a critical look at the cost of inflation.
