Speech

Inflation, Financial Stability, and Economic Growth GlobalInterdependenceCenter(GIC)AbroadinChileConference KeynoteAddress UniversidadAdolfoIbáñez Santiago,Chile March5,2007 The Federal Reserve Act as amended in cialstabilitywillbemoredifficult,ifnotimpos- 1977 directs the Federal Reserve to sible,toachieve. pursue monetary policies to achieve I’lldiscussevidencefrombothrecentand the goals of “maximum employment, not-so-recenthistorythatsupportmycontention stable prices, and moderate long-term interest thatasoundmonetarypolicy—thatis,commitrates.”TheFederalReserveandallcentralbanks tedfirmlytolong-runpricestability—isconhave also long been expected to promote finan- ducivetofinancialstabilityandeconomic cial stability. Since the 19th century, central growth.Someofthisevidenceisnotpretty—it banks have been expected to serve as lender of showshowanunstablepricelevelcanwrecka last resort to the banking system. financialsystemandharmtherealeconomy. Thegoalsofmaximumsustainableemploy- Beforeproceeding,Iwanttoemphasizethat mentandeconomicgrowth,stableprices,mod- theviewsIexpressherearemineanddonot erateinterestrates,andfinancialstabilityaretoo necessarilyreflectofficialpositionsoftheFederal oftenviewedasincompatiblewithoneanother. ReserveSystem.Ithankmycolleaguesatthe Conventionalwisdomholds,forexample,thatif FederalReserveBankofSt.Louisfortheircommonetarypolicyistoofocusedoncontrolling ments,especiallyDavidC.Wheelock,assistant inflation,thenoutputandemploymentgrowth vicepresidentintheResearchDivision,who willlikelyfallbelowtheirpotentialandfinancial providedspecialassistance.However,Iretain marketswillbelessstablethantheyotherwise fullresponsibilityforerrors. couldbe. Today,IwillelaborateonhowIseeinflation, financialstabilityandeconomicgrowthfitting SOUND MONETARY POLICY togetherinacoherentframeworkformonetary policy.Idonotsubscribetotheconventional I’llbeginbyoutliningtheessenceofsound wisdom.Neithereventsnoreconomictheory monetarypolicyandwhyIbelievethatsound supportthenotionthatamonetarypolicydirected policyisaprerequisiteforfinancialstabilityand towardpricestabilitywillresultinalessstable maximumeconomicgrowth.Thefoundationof financialsystemoranunderperformingreal asoundmonetarypolicyislong-runpricestabileconomy.Rather,inmyview,pricestability, ity.By“pricestability”Imeanalowandstable financialstabilityandeconomicgrowthare rateofinflation.Ibelievethattheoptimalrateof mutuallyconsistentgoalsformonetarypolicy. inflationiszero,properlymeasured.However, Further,Ibelievethatpricestabilitymustbethe biasesinpriceindexesimplythat,inpractice, paramountobjectiveformonetarypolicybecause pricestabilitywilllikelybeconsistentwitha withoutpricestability,thegoalsofmaximum smallpositivemeasuredrateofinflation.These employment,moderateinterestratesandfinan- biasesarisefromthedifficultyofcapturing 1

MONETARYPOLICYANDINFLATION improvementsinthequalityofgoodsandserv- barelyinsideoneendortheotherofa1to2perices,aswellassubstitutionsamongproducts centrange.Asanaside,IwouldnotethatU.S. thatcompriseconsumers’totalpurchases.Differ- monetarypolicyhascomealongwayoverthe encesinhowpriceindexesareputtogetherimply past20years,asindicatedbythefactthatIthink thatthespecificrateofinflationthatisconsis- itworthwhiletotalkaboutthedifferencebetween tentwithpricestabilitywilllikelyvaryacross agoalof1.5plusorminus0.5percentversusa countriesandovertime.FortheUnitedStates, goalof1to2percentinflation. I’llhazardaguessthatzerotrueinflationtrans- Inamarketeconomy,consumersandfirms latestoanannualrateofincreaseintheCPIof basetheirconsumptionandinvestmentdecisions about1percentandinthebroaderpriceindex oninformationderivedfromprices,including forpersonalconsumptionexpendituresofabout assetpricesandreturns.Efficientallocationof 0.5percent. economicresourcesdependsontheclarityof Bypricestability,Idonotmeanthatthe signalscomingfromthepricesystemand,Imight priceindexisconstant.Monetarypolicycould add,theclarityofsignalsfromgovernmentsand nevereliminatehigh-frequencymovementsin centralbanksabouteconomicpolicy.Uncertainty theinflationrate;norshouldpolicymakerstryto abouttheaggregatepricelevelmuddiesthewaters doso.Pricestabilitymeansthatinflationissufbymakingitdifficultforfirmsandhouseholds ficientlylowandstableasnottoinfluencethe todeterminewhetherchangesinindividual economicdecisionsofhouseholdsandfirms. pricesreflectfundamentalshiftsinsupplyand Wheninflationislowandreasonablystable, demandormerelychangesintheoverallrateof peopledonotwasteresourcesattemptingtoproinflation.Byeliminatingthisuncertainty,amontectthemselvesfrominflation.Theysaveand etarypolicythatiscommittedtolong-runprice investwithconfidencethatthevalueofmoney stabilityeliminatesapotentialdragontheeffiwillbestableovertime. cientallocationofresourcesand,hence,oneco- Ahighlypredictablefinancialenvironment nomicgrowth. notonlyrequiresalowandstablerateofinflation Long-runpricestabilitycontributestofinanbutalsowidespreadunderstandingofhowthat cialstabilityinasimilarfashion.Anunstable objectivestatedingeneraltermstranslatesinto pricelevelcanleadtobadforecastsofrealreturns day-by-daymonetarypolicyactions.Speaking toinvestmentprojectsand,hence,tounprofitable againintheU.S.context,itismoreimportant borrowingandlendingdecisions.Unexpected thatpolicymakersagreeonsomerelativelylow boutsofinflation,forexample,tendtoencourage targetrateofinflationthanexactlyonwhatthat optimisticforecastsofrealreturns.Errorsindisrateis.AnumberofFOMCmembershavespoken tinguishingnominalandrealreturnsresultin abouta“comfortzone”of1to2percentinflation, measuredbythePCEpriceindexexcludingfood misallocationofresourcesandeventuallyto andenergy—theso-called“core”inflationrate. financialdistressthatwouldnothaveoccurred Thatstatementisfullyacceptabletome.1My ifthepricelevelhadbeenstable.Businessdeciwayofstatingmycomfortzoneiscoreinflation sionsbasedonexpectationsofcontinuinginflaof1.5percentperyear,plusorminusarangeof tionoftenturnoutbadlywheninflationfalls, 0.5percenttoallowforunavoidableshort-run resultinginhigherratesofloandefaultsand fluctuations.Mystatementismeanttoindicate businessfailures.Outrightdeflationisparticularly thatIwouldlikemonetarypolicytoaimat1.5 notoriousbecauseafallingpricelevelincreases percentcoreinflationandnotjustacceptinflation therealcostofservicingoutstandingdebt. 1 Andhasbeenforalongtime.Forarelativelyrecentexample,seeWilliamPoole,“TheMonetaryPolicyModel,”NationalAssociationof BusinessEconomicsAnnualMeeting(NABE),Boston,Massachusetts, September11,2006[http://www.stlouisfed.org/news/speeches/ 2006/PDF/09_11.pdf]. 2

Inflation,FinancialStability,andEconomicGrowth Long-runpricestabilityisthemostpowerful hamperedeffortstoencourageeconomicrecovtoolthecentralbankhastopromoteeconomic ery.Hence,pricestabilitymadetheFed’sactions growth,highemploymentandfinancialstability. moreeffectivethantheyotherwisewouldhave Pricestabilityalsoenablesmonetaryauthorities been. topursuesecondaryobjectives.Worthwhilesecondarygoalsformonetarypolicyincludethe reductionoffluctuationsinrealeconomicactivity LESSONS FROM U.S. ECONOMIC andthemanagementoffinancialand/orliquidity HISTORY crises.Irefertotheseassecondarygoalsbecause thecentralbankisunlikelytobesuccessfulat Whereasrecentexperiencesupportsthe limitingfluctuationsineconomicactivityorcon- viewthatpricestabilitycontributestofinancial tainingfinancialcrisesintheabsenceofprice stabilityandeconomicgrowth,thereisnoshortstability.Thereasonisthat,intheabsenceof ageofevidencethatanunstablepricelevelleads entrenchedmarketexpectationsoflong-runprice tofinancialinstabilityandapoorlyperforming stability,basedonahighdegreeofconfidencein realeconomy.Sadly,historyisfullofexamples thecentralbank,expansionarymonetarypolicy wheremismanagedmonetarypolicyresultedin actionsriskraisinginflationexpectationsrather financialinstabilityandseriousdisruptionof thancushioninganeconomicorfinancialdistur- economicactivity.TheexperiencesoftheUnited bance.Pricestabilitymustthereforebetheprin- StatesduringtheGreatDepressionofthe1930s cipalgoalofpolicy.Acentralbankthatinvests andtheGreatInflationofthe1970sprovidetwo inachievingcredibilitywillfindthatmarket suchexamples. confidenceyieldsaveryhighrateofreturn. TheGreatDepressionisaclassicillustration TheFederalReservehasfacedanumberof ofhowfinancialdisruptionscanwreakhavocon challengesinrecenthistory,includingliquidity therealeconomy.PolicymistakesbytheFederal shocksassociatedwiththeAsianfinancialcrisis Reservewerecritical,asMiltonFriedmanand andRussiangovernmentbonddefaultin1998, AnnaSchwartzdemonstratedintheirMonetary andtheterroristattacksofSeptember11,2001. HistoryoftheUnitedStates.TheFed’sprincipal TheFed’sabilitytorespondquicklyanddeci- errorwasinfailingtoactaslenderoflastresort sivelytotheextraordinarydemandsforliquidity tothebankingsystemasbankingpanicsswept duringtheseeventswasenhancedbythefact acrosstheUnitedStates.Thecollapseofthebankthatinflationwaslowandexpectedbythepub- ingsystemcausedthemoneystocktocontract lictoremainlow.Thepublicunderstoodthatin sharply,whichcausedthepriceleveltofall. providingadditionalliquidityduringthecrises Deflationdroveuptherealcostofservicingdebt theFederalReservewasnotgivinguponitspur- andledtowidespreadbusinessfailuresand suitofpricestabilityoverthelongterm. unemployment.Fallingincomesandincreased Lowinflationandcontainedinflationexpec- loandefaultsputfurtherstrainonbanksand tationshavealsoenhancedtheFederalReserve’s otherfinancialfirms.FailureoftheFederal abilitytoreacteffectivelytobusinesscyclefluc- Reservetoactintimelyfashioncreatedadowntuations.TheFedeasedaggressivelytoencour- warddebt-deflationspiral.Morethan1,000banks ageeconomicrecoveryfromthe2001recession. wereforcedtosuspendoperationsineachyear BecausethepublichadconfidenceintheFed’s between1930and1933. commitmenttopricestability,wewereableto Themonetaryhemorrhagefinallyended bringthetargetfederalfundsratetoitslowest whentheentirebankingsystem,includingthe levelin40yearswithouttriggeringwidespread FederalReservebanks,wasshutdownbygovernfearsofhigherinflation.Ifexpectedinflation mentdecreeinMarch1933.Onceconfidencein hadrisenastheFedbroughtratesdown,long- thebankingsystemhadbeenrestored,themoney terminterestrateswouldlikelyhaverisenand stockandpricelevelbegantorise.Thereal 3

MONETARYPOLICYANDINFLATION interestratefellasthepricelevelrose,which Thereweresomenotabledissentsfromthis encouragedincreasedbusinessinvestmentand view.MiltonFriedmanandEdmundPhelps consumerspending,andtheeconomybeganto arguedstronglythatinflationarypoliciescould recover. notboostemploymentoreconomicgrowthin TheGreatDepressionillustrateshowdefla- thelongrun,andthatattemptstodosowould tioncanwreckafinancialsystemandeconomy. produceeverhigherinflationbutnomore TheGreatInflation,bycontrast,showedthe employmentorgrowththanwaspossiblewitha destructivepowerofinflation.Inflationbeganto stablepricelevel. riseinthemid1960s.Itisinterestingtocompare TheviewsofFriedmanandPhelpsbecame attitudestowardrestrictivemonetarypolicyin increasinglyacceptedinthe1970saseconomists thelate1960sandattitudesnow.Fortyyearsago, cametoappreciatetheimportanceofexpectatherewasgreatconcernintheUnitedStatesthat tionsintheeconomicdecisionmakingoffirms higherinterestrateswouldhaveanundueimpact andhouseholds.Atatheoreticallevel,economists onhousingfinanceandhousingconstruction; showedformallythatwhenthepubliccomesto thatconcerncontributedtodelaysinneeded expectthatpolicymakerswillattempttouseinfla- FederalReservepolicyactionsthatendedup tiontoboostemploymentoreconomicgrowth, destabilizingtheentireeconomy.Now,weunder- thepublicwillrespondinwaysthatprevent standthatmonetarypolicymustconcentrateon employmentoroutputfromrising.Forexample, thegoalofaggregateeconomicstabilityand ifinflationisexpectedtorise,thenworkerswill especiallyinflationcontrol.Weregardstresses demandhighernominalwagesandsaverswill inanyparticularindustryasaproblemforthat demandhighernominalinterestratestoprevent industrytodealwith;thosestressesarenotan realwagesandinterestratesfromfalling.Conseissueformonetarypolicy,unlesstheyspillover quently,oncethepublicfiguresoutthecentral totheeconomymoregenerally. bank’sgame,inflationarymonetarypolicywill Inthe1960s,politicalpressureforlowinter- havenoeffectonemploymentoroutput. estratescombinedforceswithagrowingcon- Atanempiricallevel,asthe1970sprogressed sensusamongeconomistsandpolicymakersthat theperformanceoftheeconomydiscreditedthe moderateinflationisanacceptablewaytoboost notionthathigherinflationcouldproducehigher employmentandeconomicgrowth.Monetary employmentandfastergrowth.Ifanything,the policymakingwasviewedassimplyamatterof dataindicatedjusttheopposite.Asinflation selectingfromamongamenuofinflationand rosestillhigherandbecamemorevariable,the unemploymentoptions.Choosealittlemoreinfla- averagegrowthrateoftheU.S.economyslowed tionandunemploymentwouldfall,accordingto andbusinesscyclefluctuationsbecamemore thistheory.Acceptsomewhathigherunemploy- pronounced. ment,ontheotherhand,andinflationwouldbe Inflation,andespeciallyinflationinstability, abitlower. proveddisruptiveforfinancialmarketsandfirms. TheinfamousPhillipscurvemadepolicy- Initiallytheimpactoftheintensifyinginflation makingseembeguilinglysimple.Basedonthis seemedbenignwithrespecttofinancialmarkets theory,severalinfluentialeconomistsargued andfinancialstability.Belowthesurface,howthatthemenuofinflation-unemploymentoptions ever,therisinginflationwasinteractingwiththe offeredbythePhillipscurvecouldbeimproved financialregulatorystructurethathadbeen uponifpolicymakerswerewillingtodiscard establishedinthe1930sinresponsetothefailtheirold-fashionedattractiontopricestability. uresoftheGreatDepression. Foregopricestability,theseeconomistsargued, Mutualsavingsbanksandsavingsandloan andthelabormarketwouldoperatemoreeffi- associations—the“thriftinstitutions”—had ciently,employmentwouldriseandtheeconomy becomethemainstayofhousingfinanceinthe wouldgrowfaster. UnitedStatesafterWorldWarII.Thesefinancial 4

Inflation,FinancialStability,andEconomicGrowth intermediariesborrowedshortandlentlong—a economyasawhole,butdidseverelyaffect classicdurationmismatch.Asinflationpremiums farmingregions. becamebuiltintomarketinterestrates,short-term TheU.S.inflationenvironmentwasfairly interestratesrosemuchmorerapidlythandid stableinearly1965,andfairlystableagainin thereturnonthethrifts’assets,whichwere 1985.The20yearsinbetweensawthefailureof heavilyinvestedinfixed-rate30-yearhome scoresofbanksandthriftinstitutionsandof mortgages.By1980,onamarked-to-marketbasis thousandsoffarmsandtwodeeprecessions,in thecapitalofalargeportionofthethriftindustry 1973-75and1981-82.Hundredsmorethriftinstiwasexhausted. tutionswereclosedinthelate1980sandearly Althoughtheindustrywaskeptafloatfora 1990swhentheU.S.governmentfinallyfacedup timebygovernmentsanctionedaccounting tothefactthattheyhadexhaustedtheircapital gimmicks,manythriftswerewalkingdead— duringtheGreatInflation. “zombies”somecalledthem—thathadtobe Thegeneralprinciplecommontothesecases closed.Becausethedepositliabilitiesofmost offinancialdistressisthatsignificantchangesin thriftswerefederallyinsured,thecollapseofthe theinflationratecannotbeaccuratelyforeseen. industrywascostlyfortaxpayers.Thecleanupis Forecastingerrors,andresultingfinancialloses estimatedtohavecostU.S.taxpayersbetween andbankruptcies,areinevitablewhentheprice 150and200billiondollars.Itisworthnoting levelisunstable.Inshort,inflationandinflation thatdepositinsurancedidfunctioneffectively instabilityputaneconomy’sfinancialsectorat inmaintainingthepublic’sconfidenceinthe risk. bankingsystem.Nevertheless,intheabsenceof highinflation,theepisodecouldlargelyhave beenavoided. LESSONS FROM HIGH Inflationdeclinedsharplyintheearly1980s, INFLATION EXPERIENCES thankstoachangeinthecourseofmonetary policyundertheleadershipofPaulVolcker,then AlthoughIhavefocusedonU.S.experiences, ChairmanoftheFederalReserveBoard.The whichIknowbest,manyothercountrieshave declinewaslargelyunanticipated.Becausefew seenthedeleteriouseffectsofpricelevelinstabilpeopleexpectedinflationtoremaincontained, ity.Indeed,somehavehadfarworseexperiences realinterestratessoaredassaverscontinuedto thantheUnitedStates.Manylesserdeveloped demandhighinflationriskpremiums.Thedollar countrieshaveexperiencedveryhighratesof alsoappreciatedsharplyinworldforeignexchange inflationatonetimeoranother,oftenwithdisasmarkets.ThestrongdollarwashardonU.S. trousconsequencesforfinancialstabilityand exportersandparticularlydevastatingforfarmers economicgrowth. asthedollarpricesofagriculturalcommodities Inastudyofcross-countrydata,RobertBarro fellsharply.Manyfarmershadborrowedheavily foundthathighratesofinflationsignificantly topurchaselandduringthe1970swhencommod- reduceeconomicgrowth,evenafteronecontrols itypricesweresoaringandlandvalueswere forsuchinfluencesongrowthaseducational appreciatingrapidly.Fallingcommodityand attainmentlevels,theruleoflawandstrengthof landpricesinthe1980sleftmanyfarmersunable democraticinstitutions.2MichaelBrunoand toservicetheirdebtsandmanywentbankrupt. WilliamEasterlyoftheWorldBankreportsimilar Lossesonfarmloanscausedthefailureofmany evidence.Theyfindthatinflationcrises—which banksinagriculturalregionsoftheUnitedStates. theydefineasinflationratesontheorderof40 Thisfinancialdistressdidnotspreadtothe percentormore—producesignificantshortfalls 2 RobertBarro,“InflationandGrowth.”FederalReserveBankofSt.LouisReview,May/June1996,78(3),pp.153-69. 5

MONETARYPOLICYANDINFLATION inacountry’seconomicgrowth.3Forexample, performanceoverthepast15years,whichthe whenChile’sinflationratesoaredfromanaver- IMFattributedlargelytotheimplementationof agerateof27percentbetween1960and1971to soundeconomicpolicies.Duringthe15years anaveragerateof240percentbetween1972and endingin2005,ChileenjoyedanaverageGDP 1977,thecountry’salreadymodestrateofper growthrateof5.5percent,atriplingofitsper capitaoutputgrowthdeclinedfromjustunder capitaincomeinU.S.dollarterms,andahalving theworldaveragetomorethan5percentage ofitspovertyrate,allwhilekeepingthelidon pointsbelowtheworldaverage.Brunoand inflation.TheIMFcitedChile’ssoundfiscalpoli- Easterlyshowthatothercountriesthathavehad cies,itslowbarrierstointernationaltradeand capitalflows,soundfinancialregulatoryand suchinflationaryburstsalsoexperiencedlarge supervisoryframework,afloatingexchangerate, declinesinoutputgrowth. anditsinflation-targetingframeworkformone- Perhapsthemostobviousexamplesofthe tarypolicy.Thesepolicies,theIMFargues,have destructiveforceofinflationarehyperinflations helpedkeepinflationandinflationexpectations inGermanyafterWorldWarI,invariouseastern low,sustainedeconomicgrowthandhelped EuropeancountriesafterWorldWarIIandin maketheChileaneconomyresilienttoexternal LatinAmericamorerecently.Thesewerecaused shocks.4 byprintingmoneytofinancemassivegovernment LikeChile,manycountrieshavemadeprice budgetdeficits.Hyperinflationwasendedin stabilitytheparamountobjectiveofmonetary thosecountriesbyreformsthatbroughtgovernpolicy,andseveralhaveadoptedformalinflation mentspendingundercontrolandcrediblyended targetingasawayofanchoringinflationexpecthefinancingofdeficitsbyprintingmoney. tations.Theadvantageofadoptingaformal Economistshavedebatedwhethertheterminaquantitativetargetforinflation,especiallywhen tionofhyperinflationsresultedinseriousdeclines coupledwithinstitutionalreforms,suchas inoutput.Itiscertain,however,thathyperinflaincreasedoperatingindependenceforcentral tiondidnotpromotefastergrowthorfinancial banks,isthatitreducesuncertaintyaboutthe stability.Hyperinflationswenthandinhandwith long-terminflationrate.This,inturn,reduces collapsingeconomiesandfinancialmarkets. inflationriskpremiumsininterestratesandpro- Countriesthathaveveryhighratesofinflamoteslong-termcontractingandinvestment. tiontypicallyhaveweakinstitutions,including Thesebenefitscanbeespeciallyimportantfor poorenforcementofcontractsandpropertyrights, countriesthathavehadahistoryofhighor andinefficienttaxsystems(andconsequently unstableinflation.However,Ibelievethatany largebudgetdeficits).Manycountrieshavemade countrycouldbenefitfromannouncingand effortstoimprovetheirpoliticalandeconomic stickingtoaspecificnumericinflationobjective. institutionsandarenowexperiencinglower inflationandhighereconomicgrowththanthey didbeforetheirreforms. CONCLUSION Chileisoneexampleofacountrythatappears tohaveseenadirectbenefitfromimplementing Iwillconcludebynotingthat,overthepast pro-economicgrowthpoliciesthatincludemeas- 20yearsorso,theinflationrecordoftheUnited urestocontrolinflation.Theexecutiveboardof Statesandmanyothercountrieshasbeenfar theInternationalMonetaryFund(IMF)recently betterthanitwasfromthemid1960stotheearly complimentedChileforitsenviableeconomic 1980s.Itisnotacoincidence,Ibelieve,thatwe 3 MichaelBrunoandWilliamEasterly,“InflationandGrowth:InSearchofaStableRelationship.”FederalReserveBankofSt.LouisReview, May/June1996,78(3),pp.139-46. 4 “IMFExecutiveBoardConcludes2006ArticleIVConsultationwithChile.”PublicInformationNoticeno.06/97.August11,2006. 6

Inflation,FinancialStability,andEconomicGrowth havealsohadabetterrecordofeconomicgrowth associatedwithalittleinflation,andbadtimes andfinancialstabilityovertherecenttwodecades withfallinginflationor,especially,deflation.That thanduringtheyearsofhighandhighlyvariable observationiscorrectbutincomplete.Alittle inflation.FederalReserveChairmanBenBernanke unexpectedinflationisassociatedwithtemporary hasreferredtothedeclineinthevolatilityof goodtimesbutcannotlast.Expectationscatch bothinflationandoutputoverthepast20years upwithreality.Asexpectationsandactualinflaas“TheGreatModeration.” tionrise,thegoodtimescometoanendand Duringtherecentpast,ourfinancialsystem financialinstabilitybegins.AsMiltonFriedman andeconomyhaveshownremarkableresilience arguedsobrilliantly,foraneconomyoperating inthefaceofsomeseriousshocks.Ihavealready closetofullemployment,thetrade-offisnot mentionedtheAsianfinancialcrisisandRussian betweeninflationandunemploymentbutbetween governmentbonddefaultin1998,andtheterrorist unemploymentnowandunemploymentplus attacksofSeptember11,2001.Noneofthesehad inflationlater. morethanapassingimpactonU.S.financial UndertheFederalReserveAct,theFedopermarketsorfirmsorontherealeconomy.More ateswithadualmandate,toencouragemaximum recently,wehaveseenlittlefalloutfromtheend- employmentandpricestability.Thosegoalsare ingofthehousingboom.Atleastthusfar,only notincompatiblebutfundamentallythesame theresidentialconstructionindustryandclosely goal.Maintaininglowandstableinflationiscenalliedindustriesandprofessionshaveexperi- traltoachievingmaximumemploymentandthe encedanysignificanteffectsoftheslowingof highestpossiblerateofeconomicgrowth.Mainhousingmarkets.Needlesstosay,Idoubtthatour tainingpricestabilitydoesnotrequirethatthe financialsystemoreconomywouldshowsuch centralbankcomedownhardoneveryupward resilienceifinflationwerenotlowandstable. twitchintheinflationrate,butdisciplined Monetarypolicyisnotmagic.Astablecur- responseisrequiredwhentheinflationrate rencyisanecessarybutnotsufficientcondition threatenstoriseinasustainedfashionorfall foreconomicgrowth.Ademocraticgovernment, intodeflation.Centralbankersneedtoapply abletotransferpowerpeacefullyandreliably,is theirbestjudgment,andtheywillnotalwaysbe essentialtosustainedprosperity.Soalsoare correctinthosejudgments.Butiftheyhavea soundlegaltraditionsandprocessestoresolve goodrecordandthemarketretainsconfidence disputesaccordingtothelaw.Governmentsneed thatthecentralbankwillcorrectitsmistakes, topursuepoliciesthatencourageentrepreneur- errorsinjudgmentwillnotdolastingdamage.I ialactivity.Asocialsafetynetisimportantin myselfrelyheavilyonmarketmeasuresofinflatoday’sworld,butitmustnotdestroyincentives tionexpectationsinformingmyjudgmentsand forfirmstohireproductiveworkers.Inamarket indecidingwhatpolicyriskstorun—inanuncereconomy,thosewhotakerisksshouldberewarded tainworld,itisalwaysthecasethatpolicyjudgwhentheyaresuccessfulandshouldsufferlosses mentsdependonprobabilisticcalculations. whentheyarenot.Monetarypolicycannotoffset IhopethatIhavepersuadedyouthatfinangovernmentpoliciesdestructiveofthegrowth cialstabilityandeconomicgrowthareenhanced process. bypricestability.ButIknowthatactualexperi- Ifinishbynotingacommonmisunderstand- enceintheUnitedStates,inChileandinmany ing.Inmanycountries,includingtheUnited othercountriesismorepersuasivethatwords States,thereistheviewthatgoodtimesareoften caneverbe. 7