NCPA - National Center for Policy Analysis

Sound Monetary Policy Is Compassionate

May 7, 1999

Many people advocate an expansionary monetary policy -- particularly during economic recessions -- to rapidly increase the rate of economic growth, and thereby raise employment and income. However, economists warn that the short-term benefits of a monetary expansion -- that is, inflation -- will be paid for by rising prices and an eventual monetary contraction that lowers employment and real income.

Economists Christina and David Romer examined the influence of monetary policy on poverty and inequality both over the business cycle in the United States and over the longer run in a large sample of countries. Analyzing available economic data, they found:

  • High inflation and macroeconomic instability -- gyrations between expansionary and contractionary policies -- are correlated with less rapid growth of average income and lower income equality.
  • An "anticipated" increase in inflation of one percentage point is associated with a decline in poverty of 0.2 percent.
  • However, the contraction needed to reduce the inflation rate is larger than the expansion that increased it, so the boom-bust cycle raises average poverty.

In a comparison of 66 countries, they found the average income of the poor tends to be lower in countries were monetary policy has produced higher average inflation and greater macroeconomic volatility. And ignoring countries with high rates of inflation -- more than 25 percent annually -- the researchers found that a one percentage point rise in average inflation is associated with a reduction in the poor's average income of about 9 percent.

Thus, on average, the poor are much better off in countries where monetary policy has kept inflation low and aggregate demand growth stable, and sound monetary policy is the most compassionate monetary policy to help the poor.

Source: Christina D. Romer and David H. Romer (University of California, Berkeley), "Monetary Policy and the Well-Being of the Poor," Economic Review, First Quarter 1999, Federal Reserve Bank of Kansas City.

 

Browse more articles on International Issues