Economic issue

ECON 111 - TTH 2:35-4:05

POSITION FOR A ZERO INFLATION TARGET

Targeting very low rates of inflation, even zero inflation, has merits in that it avoids the problems associated with runaway inflation or hyperinflation. Historical examples of the extreme costs of inflation are Germany in the 1920’s and the United States in the 1970’s. The excessive printing of money by Germany’s central bank under the Wei mar regime in the 1920’s led to hyperinflation there. This inflation destroyed the savings of the middle class and was so disruptive to society that it opened the door political instability and the rise of the Nazi regime. By the 1970’s the United States had been using expansionary monetary policy persistently to boost aggregate demand in the economy. The public lost faith in the Fed’s commitment to low inflation and the increasing inflationary expectations led to a wage-price spiral that crippled the U.S. economy for a decade.

P

Positive

High inflation increases the opportunity cost of holding cash balances and can induce people to hold a greater portion of their assets in interest paying accounts. However, since cash is still needed to carry out transactions, more "trips to the bank" are necessary in order to make withdrawals, wearing out the "shoe leather." These are known as shoe leather costs. In addition, inflation implies that firms will be making frequent price changes. Changing prices in and of itself has costs, such as reprinting menus. These costs are referred to as menu costs. 

• (Menu Cost - The cost to a firm resulting from changing its prices. The name stems from the cost of restaurants literally printing new menus, but economists use it to refer to the costs of changing nominal prices in general.)

Negative

High or unpredictable inflation rates are regarded as harmful to an overall economy. They add inefficiencies in the market and make it difficult for companies to budget or plan in the long-term. Inflation can act as a drag on productivity; companies are forced to shift resources away from products and services in order to focus on profit and losses from currency inflation. Uncertainty about the future purchasing power of money discourages investment and saving. Inflation can impose hidden tax increases because inflated earnings push tax payers into higher income tax rates, unless the tax brackets are indexed to inflation.

With high inflation, purchasing power is redistributed from those on fixed nominal incomes, such as some individuals whose pensions are not indexed to the price level, towards those with variable incomes whose earnings may better keep pace with the inflation.