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people’s inflation expectations.
In this regard, one important question is: What would
happen to the credibility that the central bank has
worked hard to build by keeping inflation and inflation
expectations around 2 per cent, if the target was
raised to 4 or 5 per cent? Experience shows that
moderate inflation can easily creep up to become high
inflation if people are afraid that if the central bank can
go from 2 to 4 per cent, why not from 4 to 6 per cent
and so on.
Furthermore, if money loses 4 to 5 per cent (or more)
of its purchasing power every year, it may become
less effective as a unit of measurement for goods
and services and as a store of value. Besides, history
shows that higher inflation does not yield any lasting
gains in terms of output and employment. So why not
aim for a lower inflation rate that better preserves the
value of money over time?
Finally, given the costs of inflation, it makes little
sense to aim for a higher inflation rate year after year
just so monetary policy has greater scope to use
negative interest rates to prop the economy in case
of a severe crisis, which is a rare event. This is a very
costly proposition, especially since monetary policy
can use other, non-traditional tools to provide stimulus
in exceptional circumstances.
December 2011 © Bank of Canada 2012...
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