[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

a variety of transactions, inflation interferes with the efficiency of the economy by
discouraging its holding. By taking away the real value of money, inflation acts as a
tax on those who hold money. Economists refer to this distortionary effect as an
inflation tax.
This distortion is not as important in modern economies, where individuals frequently
put their money into interest-paying checking accounts instead of keeping
their cash. As the rate of inflation increases, the interest rate paid on checking
accounts normally increases as well. Even in Argentina in the 1970s, when prices
were rising at 800 percent a month, bank accounts yielded more than this. Still,
poorer individuals who do not have checking accounts—and therefore must hold
much of what little wealth they have in the form of currency—are adversely affected.
According to the Federal Reserve’s 2001 Survey of Consumer Finances, almost 10 percent
of American families do not have a checking, savings, or money market account.
These families tend to have low incomes and little wealth.
THE ECONOMY
There are two costs of inflation to the economy as a whole. The first has to do with
relative prices. Because price increases are never perfectly coordinated, increases
in the rate of inflation lead to greater variability in relative prices. If the shoe
industry makes price adjustments only every three months, then in the third
month, right before its price increase, shoes may be relatively cheap; conversely,
right after the price increase, shoes may be relatively expensive. On the other
hand, the prices of groceries might change continually throughout the three-month
period. Therefore, the ratio of the price of groceries to the price of shoes will
change continually. An average inflation rate of only 2 or 3 percent per year does
not cause much of a problem. But when the average rate is 10 percent per month,
inflation causes real distortions in how society allocates its resources. When inflation
gets very high, individuals and firms tend to allocate considerable time and
resources to avoiding its costs and to taking advantage of the discrepancies in
prices charged by different sellers. Rather than carrying money, which quickly
erodes in value, people rush to deposit their money in interest-bearing bank
accounts.
The second economy-wide cost of inflation arises from the risk and uncertainty
that it generates. If indexing were perfect, the uncertainty about the rate of inflation
would be unimportant. But as indexing is not perfect, the resulting uncertainty
makes it difficult to plan. People saving for their retirement cannot know how much
to put aside if they do not know what a dollar will be worth in the future when they
retire. Business firms borrowing money are uncertain about the price they will
receive for the goods they produce. Firms are also hurt when they build wage increases
into multiyear contracts to reflect anticipated inflation. If for any reason a firm finds
that the prices it can charge have increased less rapidly than anticipated in the
contract, the employer suffers.
Because of these economy-wide costs, countries that experience periods of very
high inflation also tend to experience slower real economic growth.
THE COSTS OF INFLATION ∂ 511