MacroeconomicsI_working_version (1)

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Chapter 9
This relationship, known as the Fisher principle, shows that the negative effect of expected
inflation on real money demand works itself through the nominal interest rate. The nominal
interest rate includes both the forgone real opportunity cost (r) and the expected capital loss
on the nominal value of the loan (π e ). The long-run stability of the real interest implies
therefore that the nominal interest rate fully reflects expected inflation. The store-of-value
and standard-of-deferred payment properties of money are eroded when its value in terms
of the goods it can buy is deteriorating because prices keep increasing.
9.6. The Impact of Inflation, Costs of Inflation
At the beginning of the chapter we identified inflation as the rise in the general price level.
The problem is that during periods of inflation all prices and wages do not raise at the same
rate. This brings changes in relative prices. The diverging relative prices affect negatively
the economy by following ways:
• An uneven redistribution of income and wealth. The main redistribute impact works
through its effect on the real value of people’s wealth. In general, unanticipated
inflation helps those who have borrowed money and harms those who have lent money.
In other words, unforeseen inflation redistributes wealth from creditors to debtors. An
unanticipated disinflation (decline in the inflation rate) has the opposite effect.
• Distortions in the relative prices and outputs of different goods, tax rates, real
interests, or sometimes in output and employment for the entire economy.
Anticipations. The impact of the redistribution effects of inflation depends upon people’s
expectations. If inflation is expected fully (anticipated), lenders and other receivers of
income may avoid or reduce the adverse impacts of inflation on the real value of their
incomes. Accordingly, we can say in general, that unanticipated inflation is the rise in
prices whose extent was not accurately foreseen or expected.
Uneven redistribution of income and wealth and changing level and efficiency of
production are the main impacts of inflation on economy. In such cases, that inflations and
deflations are balanced and anticipated, all prices and wages are expected to shift by the
same rate, without harming or helping anyone by its run. However, such situations are not
very common. Unanticipated (unforeseen) inflation usually harms lenders or creditors,
fixed-income receivers or “log-run” investors. This type of inflation may favour profit
seekers, speculators and, of course, debtors.
Considering the costs of inflation, stable prices belong to main goals of macroeconomic
policy. Unanticipated inflation leads to failed investments, to discouraging of enterprises,
and unforeseen income redistribution. Unbalanced inflation distort relative prices, tax rate
and real interest rates. The policy aiming to lower accelerating rate of inflation is usually
costly in terms of reduced output and employment, and thus, painful.
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