Karl-Heinz Tödter and Gerhard Ziebarth*
If there is anything in the world which ought to be stable it is money, the measure of everything which enters the channels of trade.
(Francois Le Blanc 1690, quoted from Einaudi, 1953:233)
Over time, even moderate inflation erodes the value of money in its role as a unit of account, a medium of exchange and a store of value. This is why people dislike inflation (Shiller 1997). In this chapter, we investigate a central economic policy problem for Germany that has recently been posed by Feldstein (1996) as follows: ‘If the true and fully anticipated rate of inflation…has stabilised at two percent, is the gain from reducing inflation to zero worth the sacrifice in output and employment that would be required to achieve it?’
The Deutsche Bundesbank was confronted with a similar situation in the years after German unification, when inflation ranged between 3 and 4 per cent. This complex matter necessitates addressing three issues: What is the true rate of inflation? What are the costs of disinflation? What are the benefits of price stability?
The notion that price stability should be the priority target of monetary policy has become widely accepted. High and volatile inflation distorts economic allocation and curbs economic growth and welfare. But, nonetheless, opinions differ substantially with regard to the assessment of moderate inflation, especially if the benefits of price stability have to be weighed against the costs of disinflation. 1 Should a moderate pace of inflation be tolerated or even aimed at by economic policy-makers, rather than there being undue zeal to fight inflation?
Our study tries to give an empirically founded answer, from a German perspective, to these questions. Measurement issues in the consumer price index are discussed in Section 4.2. Section 4.3 presents empirical evidence
* See notes on p. 94.