Download Most of us would say that higher inflation is a

Inflation - What is It, What
Causes It, and When is It Bad
Most of us would say that higher
inflation is a bad thing. But, it is not at
all clear why we should care so much
about inflation.
How do we usually define inflation?
‘Inflation is a process of continuously rising prices, or
equivalently, of a continuously falling value of money’ (Laidler
and Parkin, 1975, p. 741) See New Palgrave Dictionary of
Economics
Surely everyone would agree that we have no measured inflation here.
Now consider a particular kind of rise in the price level. Can we argue that
there is again NO inflation? Surely there has been a fall in the purchasing
power of any given amount of money. But, is that inflation?
JUMP
It appears that there has been a mere jump in the price level - not a
continuous and sustained rise in the general level of prices. But should a
jump be considered inflation? And, what might cause a jump in the price
level like this?
Let's look a little closer and more precisely at this.
We usually just assume that the price increase was uniformly spread
over the period - it is an average
But, there are infinitely many ways we can allocate the price increase over the
period - and one of these ways includes zero inflation and a jump
Here I have used the computer to draw a curve of a
variable growing at a constant 5% per period.
Should we consider a jump here to be an increase in
inflation above 5% ?
What Factors Might Cause a Jump in the Price Level
Here is a List
(1) Bad Weather
(2) A Rise in the Foreign Exchange Rate (i.e. Price of Foreign Money)
(3) Increase in Sales Taxes
(4) A Rise in Oil Prices
(5) More Regulations (e.g. an Increase in the Minimum Wage)
Do these really cause inflation or merely jumps in the price level. Can they affect interest rates
and if so how do they do that? Should we deduct them when we have inflation computed to
get a core inflation rate? What causes inflation if these do not?
Taiwan Consumer Price Inflation
50.00
47.45
40.00
These high rates are not inflation
30.00
19.02
20.00
10.00
3.52
1.60
0.00
1960
-10.00
1964
1968
1972
1976
1980
1984
1988
1992
1996
2000
2004
2008
2012
2016
Disinflation is becoming more and more prevalent in the world
The Costs of Inflation
• Shoeleather costs
• Menu costs
• Relative price variability
• Tax distortions
• Confusion and inconvenience
• Arbitrary redistribution of wealth
• Shoeleather costs are the resources wasted when
inflation encourages people to reduce their money
holdings.
• Inflation reduces the real value of money, so people
have an incentive to minimize their cash holdings.
• Less cash requires more frequent trips to the bank to
withdraw money from interest-bearing accounts.
• The actual cost of reducing your money holdings is the
time and convenience you must sacrifice to keep less
money on hand.
• Also, extra trips to the bank take time away from
productive activities.
• Menu costs are the costs of adjusting prices.
• During inflationary times, it is necessary to update
price lists and other posted prices.
• This is a resource-consuming process that takes away
from other productive activities.
• Inflation distorts relative prices.
• Consumer decisions are distorted, and markets are less
able to allocate resources to their best use.
• Inflation exaggerates the size of capital gains and
increases the tax burden on this type of income.
• With progressive taxation, capital gains are taxed more
heavily.
• The income tax treats the nominal interest earned on
savings as income, even though part of the nominal
interest rate merely compensates for inflation.
• The after-tax real interest rate falls, making saving less
attractive.
• When the Fed increases the money supply and creates
inflation, it erodes the real value of the unit of account.
• Inflation causes dollars at different times to have
different real values.
• Therefore, with rising prices, it is more difficult to
compare real revenues, costs, and profits over time.
• Unexpected inflation redistributes wealth among the
population in a way that has nothing to do with either
merit or need.
• These redistributions occur because many loans in the
economy are specified in terms of the unit of
account—money.