Inflation is a result of increased demand with same supply (in worst case. in best case, supply also increases), due to more money on people's hand. As far as I understand it, inflated market is still a market at equilibrium.

For example, say normally a market of bicycles was at equilibrium where 1000 units bought/sold at \$1000/unit. Due to influx of money into people's hand, demand increases to 2000 units but manufactures still can only produce 1000 units. So, manufacturers increase the price to, say, \$1500/unit such that demand again drops down to 1000 units.

In above example, 1000 units are still being sold before and after inflation. Although I understand that inflation does not help, but it does not harm as well (or so I understand). So inflation will lead to new market equilibrium without harming the economy. Why, then, inflation is harmful and central banks need to intervene to rein in the inflation?


1 Answer 1


In models without nominal or real rigidities, inflation has no real effects because roughly of the argument you have in mind.

With nominal or real rigidities, inflation creates misallocation. You can see that explicitly in the math for welfare calculations in Gali's textbook, appendix of chapter 4.


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