Recent financial instability has called into question the sufficiency of low
inflation as a goal for monetary policy. This paper discusses interwar
literature bearing on this question. It begins with theories of the cycle based
on the quantity theory, and their policy prescription of price stability
supported by lender of last resort activities in the event of crises, arguing
that their neglect of fluctuations in investment was a weakness. Other
approaches are then taken up, particularly Austrian theory, which stressed the
banking system's capacity to generate relative price distortions and forced
saving. This theory was discredited by its association with nihilistic policy
prescriptions during the Great Depression. Nevertheless, its core insights were
worthwhile, and also played an important part in Robertson's more eclectic
account of the cycle. The latter, however, yielded activist policy prescriptions
of a sort that were discredited in the postwar period. Whether these now need
re-examination, or whether a low-inflation regime, in which the authorities
stand ready to resort to vigorous monetary expansion in the aftermath of asset
market problems, is adequate to maintain economic stability is still an open
question.
On 28-29 March 2003, the BIS held a conference on "Monetary
stability, financial stability and the business cycle". This event brought
together central bankers, academics and market participants to exchange views on
this issue (see the conference programme and list of participants in this
document). This paper was presented at the conference. Also included in this
publication are the comments by the discussants. The views expressed are those
of the author(s) and not those of the BIS. The opening speech at the conference
by the BIS General Manager and the prepared remarks of the four participants on
the policy panel are being published in a single volume in the BIS Papers
series.