Inflation as a Problem

Clearly, price inflation is a major modern economic phenomenon, but why is it a problem? As we have observed, there are no natural units for the measurement of purchasing power, and there is no natural landmark to tell us that one purchasing power is better than another, either. If it is important (say) that the dollar have the purchasing power it had in 1918, we could arrange that by printing bills with one fewer zeros, so the $100 bill would become a $10 bill, and so on. And some countries have done that -- though, in most cases, they were countries where the price level had gone up a hundred or a thousand times or more. So why does it matter how many zeros we have on our bills?

It probably doesn't, but most economists would say that even though the price level doesn't matter, changes in the price level do matter. A rising price level -- inflation -- has the following disadvantages:

• It creates uncertainty, in that people do not know what the money they earn today will buy tomorrow.
• Uncertainty, in turn, discourages productive activity, saving and investing.
• Inflation reduces the competitiveness of the country in international trade. If this is not offset by a devaluation of the national currency against other currencies, it makes the country's exports less attractive, and makes imports into the country more attractive, which in turn tends to create unbalance in trade.
• Inflation is a hidden tax on "nominal balances." That is, people who hold bonds and bank accounts in dollars lose the value of those accounts when the price level rises, just as if their money had been taxed away.
• The inflation tax is capricious -- some lose by it and some do not without any good economic reason.
• As the purchasing power of the monetary unit becomes less predictable, people resort to other means to carry out their business, means which use up resources and are inefficient.

These inconveniences might be reason enough to call for a stable price level. If it doesn't matter what the price level is, and changing it causes problems, why not keep it stable? But the strong concern about inflation in some countries stems from experiences that are worse than inconvenient: hyperinflation.

An Updater on Problems Measuring Inflation, Winter 1996-97

Hyperinflation