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Task of the central bank is to preserve the value of the currency. The understanding of the centrality of price stability has evolved over the years, and it is worthwhile to review selectively recent developments in thinking about this aspect of the role of the central bank, with an emphasis on unsettled and controversial issues. As long as countries adhered to the gold standard, rapid inflations were precluded, although prolonged movements in the inflation rate were evident in the nineteenth century. But, the gold standard has two fundamental disadvantages: it makes the growth rate of the monetary base currency held outside banks plus banks claims on the central bank dependent on the vagaries of the supply of gold; and it is a costly way of producing moneyprinting and book, or electronic, entry are much cheaper. However, it does in principle have the advantage of keeping control over the quantity of money out of the governments hands. The enthusiasm of central bankers and academics for this benefit led after World War I to a return to the gold standard in Europe and the spread of goldstandardbased central banking to many independent developing countries. Currency boards in a number of colonies effectively placed them too on the gold standard, at one remove. The predominant view before the Great Depression of the 1930s was that the macroeconomy was best put on automatic pilot. Britains difficulties after its return to gold in 1925, and even more the Great Depression, reduced confidence in the benefits of the automaticity of the operation of the gold standard and of the market system. Keyness General Theory, produced during the Great Depression, provided the predominant theoretical framework in which macroeconomic policy problems were analyzed during and after World War II. The General Theory does not deal with inflation, but wartime and postwar inflations made it impossible to ignore. For a time there was an awkward intellectual gap between the Keynesian model, used to determine the level of output, and the analysis of inflation, which was explained primarily through the quantity theory of money. That gap was closed by adding the Phillips curve to the Keynesian model. The original Phillips curve implied that there is a longrun tradeoff between inflation and unemployment, but that view has long since been abandoned, on empirical as well as theoretical grounds. A closely related notion, that inflation might be good for growth, has also been refuted by empirical evidence, which shows that inflation is in fact negatively correlated with growthat least at doubledigit inflation rates. See, for example, Fischer 1993 and Bruno and Easterly 1995. Some uncertainty remains about the relationship between inflation and growth at low inflation rates. In principle, there is likely to be a turning point in the relationship, since there are grounds for believing deflation is bad for growth. In my work, I have found the negative relationship to continue even in the low singledigit range. However, both Barro 1995 and Sarel 1996 do not find a clear negative relationship below 8 percent inflation, though they do confirm a strong negative relationship at higher inflation rates. Notwithstanding the uncertainty about the negative inflationgrowth correlation at inflation rates below 8 percent, no one has yet found evidence for a positive correlation over any sustained period.

 

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