Chancellors and central bankers face a perennial headache: booms typically cause inflation, while recessions mainly reduce output without reducing prices or inflation. New ESRC-funded research by Professor V. Bhaskar of the University of Essex explains how this problem emerges through the phenomenon of asymmetric price adjustment – the fact that firms are far quicker to increase prices than to cut them.
This work has important implications for inflation targeting by the Bank of England and other central banks. The Nobel Laureate Robert Lucas has recently argued that the optimal inflation target may be negative, so that central banks may need to deflate the economy persistently. But Bhaskars research on pricing asymmetries shows that deflation would aggravate the negative effects on output and employment considerably.
Positive inflation has the effect of raising output, since it prevents the output and employment losses due to price asymmetries. On the other hand, the inflation target for the central bank should not be too high, since the output gains are relatively modest.
Iain Stewart | EurekAlert!
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