Inflation. Inflation is a rise in the average price level over a given time period.
Many costs of inflation exist:
- Transfer of Resources. Inflation causes a transfer of resources from savers to borrowers. Inflation devalues savings so savers are worse off. Inflation devalues debt so borrowers are better off.
- Interest Rates. If inflation is too high a tight monetary policy may be used to increase interest rates, so the cost of borrowing rises, consumers take out less loans and consumption falls.
- Uncertainty. Inflation creates uncertainty, uncertainty means firms cannot plan, if firms cannot plan they cannot invest so investment falls. Also, if inflation is too high a tight monetary policy may be used to increase interest rates, so the cost of borrowing rises, investors take out less loans and investment falls.
- Menu Costs. As prices change, firms must change their prices and reprint menus and catalogues, edit websites and shop signs, this is costly for firms.
- Search Costs. As prices change, consumers incur search costs because they must keep up to date with all the new prices that firms charge.
- Wage-Price Spiral. As inflation occurs, workers cannot afford as much as before, workers demand higher money wages, firms’ costs rise, firms’ prices rise, workers demand higher money wages and the spiral continues. At the extreme, this could cause hyperinflation.
- International Competitiveness. A rise in country A’s prices means A becomes less internationally price competitive, A’s exports are dearer and fall, imports are cheaper so A imports more.