Sunday, April 26, 2009

why Bother About inflation ? (4)

we turn now to a fourth reason for thinking that inflation should be prevented. When the general price level rises the real value of a given sum of money decline. For example if the price level rises by 10 per cent between the beginning and the end of a particular year, a sum of $100 expressed in beginning-of-year prices will be $100\1.1 at the end of the years as compared with $100 at the beginning of the year. That is, the real value of $100 will decline by a little over 9 per cent in the course of the year. Because of this fact, wealth-holders have a strong incentive, under inflationary conditions, to keep as a little of their wealth as possible in the from of money and as much as possible in the from of assets whose price rises at least as rapidly as the general price level, and which, therefore, do not decline in real terms. This means, in turn, that both individuals and firms face if prices were stable. first, there is the time and effort (physical and mental) which they put into the task of economizing on money balance; then there is the inconvenience associated with liquidity which they suffer if they are successful in this task. If the rate of inflation is moderate-say less than 5 per cent per annum - these real costs will probably not matter very much. however, once the inflation rate climbs to something like 15-20 per cent per annum they can no longer be ignored. And in extreme inflation,when the loss of real wealth consequent on holding money become a major consideration and people seek to pass on money as quickly as possible after receiving it, the real costs in question are undoubtedly very large indeed.

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