What are the costs of inflation? Which is most important? How about deflation? Would that be a problem and for whom? The FRB worries more about deflation. Why? Do you agree? Why or why not?
There are really three major costs of inflation:
- Menu costs, the costs undertaken by businesses to update pricing (
- Shoe leather costs, the effort people have to undertake to deal with inflation
- Decrease in purchasing power, which means savings are worth less
- Redistribution of wealth from creditors to debtors.
The decrease in purchasing power hurts people with savings, which reduces demand for goods and services by say, which could lead to increased reliance on welfare, so I think it is this cost that hurts the U.S. the most
Deflation, in its literal sense, is the opposite of inflation and may be defined as a sustained decrease in the price level.
- The problem of deflationary expectations – deflation may cause people to postpone their spending in the expectation of even lower prices in the future.
- Deflation increases the value of real debt – with some inflation in the system, borrowers experience a fall in the real value of their debt over time.
- The FRD does worry more about deflation because when people see that it is deflating they expect it too keep falling , it would make it very hard for the fed to step in and cut interest rates for a higher inflation.
Macroeconomics 