The Benefits and Costs of Inflation

The benefits and costs of inflation

Inflation can have serious adverse effects or costs, and the seriousness of the adverse effects depends on whether inflation is anticipated or unanticipated. If inflation could be anticipated with complete certainty, it would pose few problems. Households and firms would simply build the expected rate of inflation into their economic decisions, which would not be distorted by wrong guesses.

When inflation is relatively low, with little variation from year to year, it is relatively easy to anticipate next year's inflation rate. Indeed, creeping inflation, which is growing markets, healthy profits and a general climate if business optimism, greases the wheels of the economy. Viewed in this way, a low rate of inflation - and not absolute price stability or zero inflation - may be a necessary side-effect or cost of expansionary policies to reduce unemployment.

A low but stable inflation rate may also be necessary tto make labour markets function efficiently. Even if average real wage rates are rising, there will be some labour markets in which real wages must fall in order to maintain a low rate of unemployment. When prices are completely stable, to cut real wage rates, nominal wage rates have to fall. To save jobs, workers may be willing to accept falling real wages caused by nominal wage rates rising at a slower rate than inflation. However, workers are much…