Inflationary bias

Inflationary bias is the outcome of discretionary government policy that, under perfect foresight in the labor market, leads to a higher than optimal level of inflation and no transitory income increase. The term may also refer to the practice of a public debt-ridden nation enacting policies which encourage inflation in the medium/long term.

Explanations

The Barro–Gordon model shows how the ability of government to manipulate leads to inflationary bias.^[1] In this model, it is assumed that a nation will attempt to keep the unemployment rate below its natural level. This will create an inflation in wages above their natural level, which ultimately results in an overall rate of inflation that is higher than the natural rate of inflation.

Traditional theories suggest that inflationary bias will exist when monetary and fiscal policy is discretionary rather than rule based. Others have suggested that the inflationary bias exists even when policy makers do not have the goal of a lower than natural rate of employment, and their policies are based on rules.

Prevention

Because of the dangers of inflationary bias, several measures have been suggested to prevent it. It has been proposed that states should have conservative central bankers. It has even been suggested that states should create inflationary goals, and if this inflation rate is exceeded, there should be some form of punishment for the central banker.^[2]

Further reading

• Kydland-Prescott Model

References