Less Than Zero: The Case for a Falling Price Level in a Growing Economy

Not long ago, many economists were convinced that monetary policy should aim at achieving “full employment.” Those who looked upon monetary expansion as a way to eradicate almost all unemployment failed to appreciate that persistent unemployment is a nonmonetary or “natural” economic condition which no amount of monetary medicine can cure.

Today most of us know better: both theory and experience have taught us that trying to hold unemployment below its “natural rate” through monetary expansion is like trying to relieve a hangover by having another drink: in both cases, the prescribed cure eventually makes the patient worse off.

Heeding this “natural rate” perspective, several governments — including those of Great Britain, the US, Canada, Australia, and New Zealand — have taken or are considering steps to relieve their central banks of responsibility for creating jobs, allowing them to focus instead on something central banks can do: limiting movements in the general level of output prices.

This new trend in monetary policy raises a question of fundamental importance to both economists and policy makers: how should we want the price level to behave?