Monday 261102

 

Mostly summarized from Gregory Mankiw’s Principles of Economics, 5th Ed.

PART 10 Money and Prices in the Long Run

Chapter 30 of 36 Money Growth and Inflation

Section 22 of 24

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Economists have identified several costs of inflation

· shoe leather costs

· menu costs

· inflation-induced tax distortions

· confusion and inconvenience

· arbitrary redistribution of wealth

All create relative price variability and the misallocation of resources.

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Arbitrary Redistributions of Wealth

The costs of inflation occur even when inflation is steady and predictable.

Inflation has an additional cost when it is not predicted.

Unexpected inflation redistributes wealth among the population in a way not connected with either merit or need.

Suppose Sam Student, to cover college expenses gets a $20,000 loan from Bigbank at a 7% interest rate.

For simplicity all interest is to be paid when the loan is due for payback in 10 years.

Sam will owe Bigbank $40,000 after his debt has compounded for 10 years at 7%.

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The real value of this debt will depend on inflation over the 10 years.

If Sam is fortunate, the economy will have a period of high inflation.

If the economy goes through a period of high inflation wages and prices will rise and the $40,000 debt will become a much smaller burden than anticipated.

But if the economy goes through a period of deflation wages and prices will fall and the $40,000 debt will become a greater burden than anticipated.

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Unexpected changes in prices redistribute wealth among debtors and creditors.

A period of high inflation enriches Sam at the expense of Bigbank because it diminishes the real value of the debt.

Sam can repay the loan in less valuable dollars than anticipated.

A period of deflation enriches Bigbank at Sam's expense because it increases the real value of the debt.

Sam must repay the loan in more valuable dollars than anticipated.

If inflation were predictable Bigbank and Sam could take inflation into account when setting and agreeing to the loan nominal interest rate.

But when inflation is not predictable an accurate nominal interest rate cannot be set, imposing uncertainty and risk on Sam and Bigbank.

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Inflation is especially volatile and uncertain during periods of high average inflation.

Low average inflation countries such as Germany in the late 20th century tend to have stable inflation.

High average inflation countries such as in many Latin American ones in recent years tend to have unstable inflation.

In fact, there are no known examples of economies with high, stable inflation.

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there are no known examples

kichi no rei wa nai

既知の例はない

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What were the political ramifications of the U.S. deflationary period of the late 1800s? CGPT:

The political effect was substantial: indebted farmers, especially in the South and West, organized through the Grange, Farmers’ Alliances, and eventually the Populist Party, demanding policies that would raise prices and reduce the real burden of debt.

Their most famous demand was “free silver” —expanding the money supply by allowing more silver coinage— which they hoped would create moderate inflation and make debts easier to repay.

The issue became central in the 1896 presidential election, when Democrat William Jennings Bryan attacked the gold standard in his famous “Cross of Gold” campaign, while Republican William McKinley defended it.

McKinley won, and the U.S. formally committed to the gold standard in 1900.