Olivier Blanchard, the highly respected Chief Economist for the International Monetary Fund, has proposed that central banks raise their inflation targets from 2% to 4%. He argued that this would give central banks more leeway to stimulate the economy when unemployment rates are rising and economic growth is decelerating since there would be more scope for reducing interest rates.

Die-hard monetarists immediately went apoplectic, condemning this suggestion and renewing their calls for all major central banks to follow the lead of Australia and start raising rates. Obviously, these economists see inflation lurking everywhere. Every sign of recovery terrifies them, even though the recovery is in its early stages and its sustainability is far from certain.

At the same time, there are other, more pragmatic economists who warn that deflation is the greater risk, pointing to Japan as the poster child, and they demand more stimulus. The stimulus would have to come from government spending since interest rates are about as low as they can get at this time – lending credence to Blanchard’s basic argument.

So what is it – inflation or deflation? I suspect that neither is the problem on the horizon, although policy makers should closely monitor the recovery to ensure that it will have the legs necessary to sharply lower unemployment rates.

Back to the monetarists: here is a group that has had its collective head in the ground for at least 20 years. Inflation has not been a problem since the early 1990s despite the policies of the major central banks. During the 1990s as unemployment rates dropped steadily, especially in the U.S., monetarists repeatedly issued dire warnings about the imminent acceleration of the rate of inflation. Yet this never materialized, largely because their simplistic models failed to account for the integration and expansion of China in the global economy. To his credit, Alan Greenspan finally realized that the world had changed in the late 1990s and that some of the old economic models no longer provided a good guide for the future path of the rate of inflation.

Monetary policy is much more effective in braking the economy than in stimulating it, even if Blanchard’s advice was followed. But monetarists dread any type of interventionist government policy. They believe that the economy is able to adjust quickly, and some even believe painlessly, to any type of economic shock. If we had listened to the hard core monetarists, governments would not have done anything in 2008 when the global economy was sinking into the worst recession in 70 years. It might have been worthwhile to do so just to have them rationalize why most major economies had slipped into depression rather than self correct.

High interest rates can slow down economic activity and lessen inflationary pressures. The problem lies in comparing the economic and social costs of inflation and unemployment under different policy scenarios. In 1990, John Crow, the Governor of the Bank of Canada at that time, and a hero to monetarists in Canada, slammed the brakes to bring inflation under control. He succeeded in creating the first made in Canada recession. The inflation rate did decline, but at an enormous cost in higher unemployment rates. If he had followed a more moderate policy, it would have taken longer to bring the inflation rate under control, but the unemployment rate would not have risen as sharply and stayed as high for as long as it did.

Was it it worth it? For monetarists it was. For those who lost their jobs, the answer was probably much different.

So, should central banks err on the side of unemployment or the side of inflation? For me the answer has always been obvious.

The opinions expressed in this blog are personal and do not reflect the views of either Global Brief or the Glendon School of Public and International Affairs.