An analysis of the welfare consequences of inflation and disinflation shows that a moderately increasing price level is associated with a higher level of social welfare than is a perfectly stable price level. This result lends support to the view that little inflation is good for the economy. The analysis shows that the eradication of moderate inflation also increases social welfare, but these results are not contradictory. The first result arises from the fact that, when there is low inflation, a firm's real price will generally be lower than the real price it would charge if there is no inflation. The 2nd result comes from a tendency to avoid costly price adjustments after inflation has been brought under control. The model assumes that firms incur a fixed cost of nominal price adjustment. Distributional effects are eliminated by assuming that all consumers are identical and own the same fraction of all firms. Distributional effects cannot be ignored in a more realistic setting, however.
|Journal||American Economic Review|
|State||Published - 1988|
- Disinflation ; Economic models ; Economics ; Inflation ; Mathematical models ; Monopolies ; Price levels ; Public assistance programs ; Statistics ; Utility ; Welfare economics