688 PA R T V I I Monetary Theory a policy rule whereby the Bank of Canada keeps the money supply growing at a constant rate This monetarist rule is referred to as a constant-moneygrowth-rate rule Because of the misbehaviour of velocity of M1 and M2, monetarists such as Bennett McCallum and Alan Meltzer of Carnegie-Mellon University now advocate a rule for the growth of the monetary base that is adjusted for past velocity changes As our analysis indicates, an important element for the success of a nonaccommodating policy rule is that it be credible The public must believe that policymakers will be tough and not accede to a cost push by shifting the aggregate demand curve to the right to eliminate unemployment In other words, government policymakers need credibility as inflation-fighters in the eyes of the public Otherwise, workers will be more likely to push for higher wages, which will shift the aggregate supply curve leftward after the economy reaches full employment at a point such as point in Figure 26-11 (page 684) and will lead to unemployment or inflation (or both) Alternatively, a credible, nonaccommodating policy rule has the benefit that it makes a cost push less likely and thus helps prevent inflation and potential increases in unemployment The following application suggests that recent historical experience is consistent with the importance of credibility to successful policymaking APP LI CAT IO N Importance of Credibility to the Bank of Canada s Victory over Inflation In the period from 1965 through the 1970s, policymakers had little credibility as inflation-fighters a well-deserved reputation, as they pursued a discretionary accommodating policy to achieve high employment As we have seen, the outcome was not a happy one Inflation soared to double-digit levels, while the unemployment rate remained high To wring inflation out of the system, the Bank of Canada under governor Gerald Bouey put the economy through two back-toback recessions in 1980 and 1981 1982 (The data on inflation, money growth, and unemployment in this period are shown in Figures 26-8 and 26-10 on pages 682 and 683.) Only after the 1981 1982 recession the most severe in the postwar period, with unemployment above the 10% level did Bouey establish credibility for the Bank of Canada s anti-inflation policy By the end of 1983, inflation was running at a rate of less than 5% From November 1982 to January 1988, the primary objective of the Bank of Canada was price stability in the longer term and inflation containment in the shorter term This policy, however, was carried out without intermediate targets or a specified path to the longer-term goal In January 1988, John Crow, the governor of the Bank of Canada, announced that the Bank would subsequently pursue an objective of price stability One indication of the Bank of Canada s credibility came in 1991 when the Bank and the Department of Finance jointly announced inflation targets This convinced the public and the markets that if inflation reared its head, the Bank of Canada would pursue a nonaccommodating policy of quashing it Workers and firms did not raise wages and prices, which would have led to both inflation and unemployment The success of the Bank s anti-inflation policy has been continuing to date the inflation rate has been running at a rate of less than 3% The Bank of Canada s triumph over inflation was achieved because it obtained credibility the hard way: it earned it