3
$\begingroup$

We all know high inflation is bad. Bad things happen. However:

  • Do we have an authoritative source explaining why inflation is bad and should be prevented?
  • Has anyone pinpointed the main root cause or mechanism by which high inflation causes disaster?
  • Do we have something similar to an "official" explanation?
$\endgroup$
8
  • $\begingroup$ Does this answer your question? Is zero inflation desirable? $\endgroup$
    – Giskard
    Aug 10 at 14:48
  • 1
    $\begingroup$ That one flies miles above my head, TBH. I hope my previous comment mixing up AI explainability with the 5 whys technique is more helpful and clarifying than confusing. I have an extraordinary ability to be confusing, TBH. In any case, thanks a lot for your interest. $\endgroup$
    – Trylks
    Aug 10 at 15:22
  • 2
    $\begingroup$ I am not sure what you ask to be honest. In the question you ask for the main cause why inflation is bad. In the comment you mention you are not interested in what bad things happen. The reason you should not ingest ricin is that it is a deadly poison that kills you. Or are you interested in something like "Ricin is a glycoprotein that interferes with protein synthesis in the cell (causing cell death). However, even in this example the main problem is the bad thing that happens (death). $\endgroup$
    – Alex
    Aug 10 at 15:57
  • 1
    $\begingroup$ The 2% target is random to some degree. Note also that emerging economies often have higher targets. They key reasoning seems to be that "high" inflation, especially when inflation is very volatile, makes economic decision making difficult. See also here: frbsf.org/education/publications/doctor-econ/1998/june/…. $\endgroup$
    – BrsG
    Aug 10 at 17:46
  • 1
    $\begingroup$ I agree with @Alex. Generally, I think the Wikipedia article about inflation mentions plenty of reasons for inflation (the root cause) as well as the bad things that happen (why it is bad). $\endgroup$
    – AKdemy
    Aug 10 at 21:32

1 Answer 1

3
$\begingroup$

Do we have an authoritative source explaining why inflation is bad and should be prevented?

Yes, for example Mankiw Macroeconomics is peer reviewed textbook (hence it is arguably authoritative source) mentions several negative effects (see pp 102):

Consider first the case of expected inflation. ... One cost is the distortion of the inflation tax on the amount of money people hold. As we have already discussed, a higher inflation rate leads to a higher nominal interest rate, which in turn leads to lower real money balances. If people are to hold lower money balances on average, they must make more frequent trips to the bank to withdraw money—for example, they might withdraw \$50 twice a week rather than \$100 once a week. The inconvenience of reducing money holding is metaphorically called the shoeleather cost of inflation, because walking to the bank more often causes one’s shoes to wear out more quickly.

A second cost of inflation arises because high inflation induces firms to change their posted prices more often. Changing prices is sometimes costly: for example, it may require printing and distributing a new catalog. These costs are called menu costs, because the higher the rate of inflation, the more often restaurants have to print new menus.

A third cost of inflation arises because firms facing menu costs change prices infrequently; therefore, the higher the rate of inflation, the greater the variability in relative prices. For example, suppose a firm issues a new catalog every January. If there is no inflation, then the firm’s prices relative to the overall price level are constant over the year. Yet if inflation is 1 percent per month, then from the beginning to the end of the year the firm’s relative prices fall by 12 percent. Sales from this catalog will tend to be low early in the year (when its prices are relatively high) and high later in the year (when its prices are relatively low). Hence, when inflation induces variability in relative prices, it leads to microeconomic inefficiencies in the allocation of resources.

A fourth cost of inflation results from the tax laws. Many provisions of the tax code do not take into account the effects of inflation. Inflation can alter individuals’ tax liability, often in ways that lawmakers did not intend.

A fifth cost of inflation is the inconvenience of living in a world with a changing price level. Money is the yardstick with which we measure economic transactions. When there is inflation, that yardstick is changing in length.

Unexpected inflation has an effect that is more pernicious than any of the costs of steady, anticipated inflation: it arbitrarily redistributes wealth among individuals. You can see how this works by examining long-term loans. Most loan agreements specify a nominal interest rate, which is based on the rate of inflation expected at the time of the agreement. If inflation turns out differently from what was expected, the ex post real return that the debtor pays to the creditor differs from what both parties anticipated. On the one hand, if inflation turns out to be higher than expected, the debtor wins and the creditor loses because the debtor repays the loan with less valuable dollars. On the other hand, if inflation turns out to be lower than expected, the creditor wins and the debtor loses because the repayment is worth more than the two parties anticipated.

Unanticipated inflation also hurts individuals on fixed pensions. Workers and firms often agree on a fixed nominal pension when the worker retires (or even earlier). Because the pension is deferred earnings, the worker is essentially providing the firm a loan: the worker provides labor services to the firm while young but does not get fully paid until old age. Like any creditor, the worker is hurt when inflation is higher than anticipated. Like any debtor, the firm is hurt when inflation is lower than anticipated.

Finally, in thinking about the costs of inflation, it is important to note a widely documented but little understood fact: high inflation is variable inflation. That is, countries with high average inflation also tend to have inflation rates that change greatly from year to year

Has anyone pinpointed the main root cause or mechanism by which high inflation causes disaster?

Yes, for example the work on the menu cost explanation was done by Mankiw, Weiss and others. Each of the areas mentioned above are quite broad, it is not possible to give justice to every scholar who contributed to these discoveries in SE format.

Do we have something similar to an "official" explanation?

The textbook explanation can be also considered an "official" explanation. There is no official authority in science but the above mentioned explanations are generally accepted by majority of economists.

$\endgroup$
1
  • $\begingroup$ I have accepted this answer as it seems to be the correct answer according to comments to the question, Wikipedia, etc. I was expecting the main reason in malinvestment (or decision making as mentioned by @BrsG). In particular, high inflation promotes investment and penalizes saving. Similar to the precision-recall tradeoff, we may expect more investment to result in a higher malinvestment ratio, destroying wealth. $\endgroup$
    – Trylks
    Aug 11 at 23:26

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.