weak price pressures. see kalemli - ozcan, s., laeven, l., and d. moreno ( 2015 ), “ debt overhang, rollover risk and investment in europe “, mimeo. kydland, f. and e. prescott ( 1977 ), “ rules rather than discretion : the inconsistency of optimal plans ”, journal of political economy, 85, 473 – 490. barro, r. and d. gordon ( 1983 ), “ rules, discretion and reputation in a model of monetary policy ”, journal of monetary economics, 12, 101 – 120. bis central bankers ’ speeches indeed, eggertsson and pugsley ( 2006 ) show that, in a fragile post - crisis situation where monetary policy is sustaining the recovery, any perception that the central bank is adopting a greater tolerance towards a future regime of lower inflation can have very negative effects. looking at the great depression period, they argue that the return of the us economy to recession in 1937 resulted from a perception that the fed had abandoned its commitment to reflation, creating pessimistic expectations of future growth and inflation that fed into both expected and actual deflation. the economy then became caught in an equilibrium of “ contractionary beliefs ”. 10 third, once central banks let inflation expectations drift away from their previous anchor and fail to counteract this through forceful policy action, there is no guarantee that expectations will naturally settle at another desirable level. as orphanides and williams ( 2004 ) show, it is precisely by defending its inflation objective that the central bank facilitates the public in learning how to process the flow of information, and thereby influences the formation of inflation expectations. 11 without such an orientation, expectations may continue to drift in the same direction, and a re - anchoring of inflation expectations may morph into an outright de - anchoring of inflation expectations with no visible end - point. in such conditions, monetary policy would face an uphill battle to preserve inflation rates compatible with any reasonable definition of price stability. to see this, consider a simple phillips curve framework that relates inflation to measures of economic slack. accommodative monetary policy reduces the degree of economic slack and thereby puts upward pressures on inflation – a move of the economy along a given phillips curve. but when inflation expectations change, this is not the only dynamic pattern taking place. instead, a change in inflation expectations alters the inflation rate to which the economy will gravitate when it

peter praet : the european central bank ’ s fight against low inflation – reasons and consequences speech by mr peter praet, member of the executive board of the european central bank, at luiss school of european political economy, rome, 4 april 2016. * * * i would like to thank jonathan yiangou, john hutchinson and federic holm - hadulla for their contributions to this speech. accompanying slides can be found on the european central bank ’ s website. in the last half century central banks have come a long way in how they approach their macro - stabilisation functions. as recently as the late 1970s, views still diverged across advanced economy central banks as to the efficacy of monetary policy in delivering price stability. some, such as the bundesbank and the swiss national bank, were already committed to using monetary measures to control inflation. but others, such as the federal reserve and various european central banks, remained more pessimistic in their outlook, believing that monetary policy was an inefficient means to tame inflation and that other policies should be better employed. 1 illustrating this view, fed chairman william miller observed in his first fomc meeting in march 1978 that “ inflation is going to be left to the federal reserve and that ’ s going to be bad news. an effective program to reduce the rate of inflation has to extend beyond monetary policy and needs to be complemented by programs designed to enhance competition and to correct structural problems ”. 2 in this context of timidity about the effectiveness of policy, inflation expectations were allowed to de - anchor, opening the door to bouts of double - digit price rises. the outcome was a phase of so - called “ stagflation ”, where both inflation and unemployment rose in tandem. the policy lesson that emerged from this period was that sustainable growth could not be separated from price stability, and that price stability in turn depended on a credible and committed monetary policy. from late 1979 onwards – with volcker ’ s assumption of the fed chairmanship – central banks converged towards this orientation and took ownership for fulfilling their inflation mandates. as their renewed commitment to control inflation became understood, inflation rates fell steeply in a context of improved anchoring of inflation expectations. central banks abandoned the self - absolving notion that price stability depended on other, non - monetary authorities. as is well - known, the events that led to the 2008 crash confirmed that price stability is not a sufficient condition for macroeconomic stability