...against fictions and other tall tales

Saturday, 5 March 2011

Is inflation always and everywhere...a bad thing?*

It always amazes me how much people fear even the smallest increase in prices. The recent spike in the price of oil has had the effect of elevating this fear to a higher level. But is inflation really that bad? I would tend to disagree given I view inflation in the same way as economist Robert Eisner in his book The Misunderstood Economy: What counts and how to count it (Boston: HBSP, 1994). According to Eisner,
[h]igher prices hurt buyers, but they help sellers. And inflation, it must be understood, is a general increase in prices, an increase in the average of all prices, including wages and salaries...Since for every buyer there must be a seller, there is no prima facie case that moderate inflation in the aggregate, hurts more than it helps. (p.147)
Of course, we all know there are distributive effects associated with unanticipated inflation, when prices and wages and interest rates and people's portfolio (i.e. mix of investments) do not adjust. Under these circumstances, some individuals may benefit while others do not (keeping in mind that, although the distribution of income and of wealth may change, their totals are not affected). However, aside from these distributive effects, there is very little evidence that at low levels inflation acts as an impediment to growth. By the way, this is not a controversial statement only supported by small, fringe segment of the economics profession. It is a view shared by several well-known mainstream economists.

So what is moderate inflation? According to a study by economist Robert Barro, inflation as high as 10 percent has no effect at all on growth ("Inflation and Growth", Review of Federal Bank of St Louis, 1996, vol 78, no. 3). Other studies give a similar result (i.e. in that they fail to identify a statistically reliable effect of inflation on growth). See, for instance, Michael Sarel, "Non-linear effects of inflation on economic growth", IMF Staff Papers, 1996, vol. 43, March.

* The title is a pun based on Milton Friedman's dictum about inflation being "always and everywhere a monetary phenomenon".

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