Understanding Lowflation

Central banks are viewed as having a demonstrated ability to lower long-run inflation. Since the Financial Crisis, however, the central banks in some jurisdictions seem almost powerless to accom- plish the opposite. In this article, we of

fer an explanation for why this may be the case. Because cen- tral banks have limited instruments, long-run inflation is ultimately determined by fiscal policy. Central bank control of long-run inflation therefore ultimately hinges on its ability to gain fiscal compliance with its objectives. This ability is shown to be inherently easier for a central bank deter- mined to lower inflation than for a central bank determined to accomplish the opposite. Among other things, the analysis here suggests that for the central banks of advanced economies, any stated inflation target is more credibly viewed as a ceiling. (JEL: E31, E52, E58, E62, E63)