Question

money theory and policy

Discuss the factors that explain why the optimal inflation rate should be positive.

Answer 1

the optimal inflation rate should be positive because -

Higher wages -

Rising prices make it easier for companies to put up wages. They also give employers the flexibility not to increase wages by as much as inflation, but still offer their staff some sort of rise. In a world of zero inflation some companies might be forced to cut wages.That would not be good for morale, recruitment or productivity. For most of the last five years inflation has been running ahead of wage rises, but thanks to inflation, wages have also been rising, even if the money doesn't go as far.

It lead to high liquidity and higher credit demand -

Anyone with a mortgage or a loan benefits from inflation, as it has the effect of eroding debt. In the 1960s my father bought a house for £11,000. But with inflation peaking at around 13% in the late 70s, his wages were rising fast too - meaning the mortgage repayments were taking an ever smaller share of his income. By contrast, deflation - or falling prices - increases the real value of debts.

Deficit eroded due to inflation -

The government has a huge debt, which can be eroded due to inflation . It would dearly love to see that eroded by inflation, which in turn would see its own income rise. As long as there's a good dose of inflation in the system, tax revenue should go up, even if the economy is stagnant.