Economic Costs of Inflation

By: EconomyWatch   Date: 14 October 2010

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The Economic Costs of Inflation deal with and measures the marginal costs of producing money. Like all other productions, the economic costs of inflation involve the appropriate "price" of money, which in this case, is the nominal rate of interest. This "price" of money indicates the return which must be pre-determined to hold back dollars, in place of some other assets which offer the market interest rate.

Low inflation can be considered as one of the costs of inflation. However, low inflation is regarded as the primary macro-economic goal in most of the Western nations.

The economic costs of inflation are many. They are stated and briefly illustrated below:
  • Global competitiveness: Inflation initiates competitiveness in the worldwide markets. The higher are the prices of the products of a country, the lesser are the scopes of competition, which subsequently reduces the country's exports. But, this situation may be counterbalanced if there is a fall in the exchange rate.

  • Disorder and improbability: With high inflation, the inhabitants of a country become indecisive about the ways of spending their money, and what to spend their money on. It is under this circumstance that the country's commercial firms become indifferent and less willing towards investment, as they are not sure about their future profits.

  • Boom and Bust economic Cycles: Generally, the high inflationary growth is followed by a collapse, as such constant situation becomes unbearable at times. It is low inflation which initiates a sustained growth in the economy of a country. It is beneficial and harmless in nature, for allowing easy and smooth price adjustments.

  • Cost of decreasing inflation: High inflation is believed to be unacceptable. Hence the governments of different countries across the world feel that it is best to decrease inflation. This attempt involves high rates of interest. However, a fall in the inflation may lead to decline in the economic growth and development of a nation, and increase in unemployment problems.

  • Re-allocation of income: With redistribution of income, the economic conditions of the borrowers improve and that of the lenders, deteriorate. However, this situation is more dependent on the real interest rates.

  • Shoe leather costs: mean making savings on losing bank interests. As a result, the customers hold less cash amounts and frequent the banks more.

  • Menu Costs: indicates the cost associated with the changing price lists.


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