Hi everyone, I’m in charge of this part, the cost of inflation.
Well, when you ask a typical
person why inflation is bad, they will say that “Inflation robs them of the purchasing
power of his hard-earned dollars”. When prices rise, each dollar of income buys fewer
goods and services, and inflation directly affect the living standards. When prices rise,
buyers of goods and services pay more for what they buy. At the same time, however,
sellers of goods and services get more for what they sell. Inflation in incomes goes hand
in hand with inflation in prices, so inflation does not in itself reduce people's real
purchasing power.
Inflation is like a tax on the holders of money. Yet most taxes give people an incentive to
alter their behavior to avoid paying the tax. How can a person avoid paying the
inflation tax. Because inflation erodes the real value of the money in your wallet, you
can avoid the inflation tax by holding less money. For example, rather than withdrawing
$200 every four weeks, you might withdraw $50 once a week. By making more frequent
trips to the bank, you can keep more of your wealth in your interest-bearing savings
account and less in your wallet. The cost of reducing your money holdings is called the
shoeleather cost of inflation because making more frequent trips to the bank causes your
shoes to wear out more quickly. However, this term is not to be understood as this
meaning, it is the time and convenience you must sacrifice to keep less money on hand
than you would if there were no inflation.
Firms change prices infrequently because there are costs to changing prices. And the
costs of chaging prices are called Menu costs. Inflation increases the menu cost that
firms must bear.
"Relative prices" refer to the prices of goods and services in comparison to each other
within an economy. Market economies rely on relative prices to allocate scarce
resources. Consumers decide what to buy by comparing the quality and prices of various
goods and services. Through these decisions, they determine how the scarce factors of
production are allocated among industries and firms. When inflation distorts relative
prices, consumer decisions are distorted and markets are less able to allocate resources to
their best use.
Almost all taxes distort incentives, cause people to alter their behavior, and lead to a less
efficient allocation of the economy's resources. Many taxes: more problematic in the
presence of inflation. Capital gains are profits when selling an asset for more than its
purchase price. Inflation discourages saving because it exaggerates the size of capital
gains and increases the tax burden.
Next is tax treatment of interest income. The income tax treats the nominal interest
earned on savings as income, even though part of the nominal interest rate compensates
for inflation. Higher inflation tends to discourage people from saving. To be more
specific, let’s look at this table.
The table compares two economies, both of which tax interest income at a rate of 25
percent………………………………..because the after-tax real interest rate provides the
incentive to save, saving is much less attractive in the economy with inflation (Economy
B) than in the economy with stable prices (Economy A).
Next, come to confusion and inconvenience. Money is the yardstick with which we
measure economic transactions. The Fed’s job ensures the reliability of money. When the
Fed increases the money supply and creates inflation, it erodes the real value of the unit
of account.
The costs of inflation we have discussed occur even if inflation is steady and predictable.
Inflation has another cost, when it comes with surprise. Unexpected inflation redistributes
wealth among the population in a way that not merit and need. It redistributes wealth
among debtors and creditors. Inflation is especially volatile and uncertain when the
average rate of inflation is high.
Some economists have suggested that a small and predictable amount of deflation may be
desirable