Impact of Inflation

Inflation is the most commonly used economic term in the popular
media. A Nexis search in 1996 found 872,000 news stories over the
past twenty years that used the word inflation. “Unemployment” ran
a distant second. Public concern about inflation generally heats up
in step with inflation itself. Though economists do not always agree
about when inflation starts to interfere with market signals, the public
tends to express serious alarm once the inflation rate rises above 5 or
6 percent. Public opinion polls show minimal concern about rising prices during
the early 1960s, as inflation was low. Concern rose with inflation in the late 1960s
and early 1970s. When inflation twice surged to double-digit levels in the mid and
late 1970s, Americans named it public enemy number one. Since the late 1980s,
public anxiety has abated along with inflation itself.

Yet even when inflation is low, Americans tend to perceive a morality tale in its effects. A recent
survey by Yale economist Robert Shiller found that many Americans view differences in prices
over time as a reflection of fundamental changes in the values of our society, rather than of purely
Economists think of inflation more plainly as a “sustained
rise in the general level of prices.” Their concerns focus
on questions such as whether inflation distorts economic
decisions. Very high inflation adversely impacts economic
performance, as evidence from cross-country studies
shows. Likewise, moderate levels of inflation can distort
investment and consumption decisions. Recent U.S.

We Will Write a Custom Essay Specifically
For You For Only $13.90/page!

order now

experience with low, stable levels of inflation, in the range
of 2 to 3 percent, has spurred policy makers to consider
the possibility of achieving zero percent inflation.
Reducing inflation however has costs in lost output and
unemployment during the adjustment. Thus, an important
question is whether zero percent inflation is sufficiently
better for the economy than 2 to 3 percent inflation to
warrant the effort of getting there.
Americans are most concerned that inflation may lower their standard of living — that their
incomes will not keep up with the rise in prices.
This anxiety is particularly pronounced for retirees, uneasy about inflation adjustments to their
pensions and financial investments. To plan for retirement requires forming expectations of prices
in the future. Inflation makes this more difficult because even a series of small, unanticipated
increases in the general price level can significantly erode the real (adjusted for inflation) value of
savings over time. Shiller finds that worry about inflation’s costs increases dramatically as
individuals near retirement age. Americans born before or after 1940 differ more in their
evaluation of inflation’s effects than do the U.S. and German populations as a whole.
effects of inflation uncertainty
Many people understand prices rise because of inflation. But they seem to attribute nominal
increases in their wages more to their own accomplishments than to the feedback effect of
To the extent that they acknowledge feedback effects, most Americans seem to believe in a
“lagged wage-price” model of the economy. That is, they assume that price increases occur first
and wage increases follow, often much later. Shiller’s survey found a striking number of people —
over 75 percent of respondents — believe that their income would not fully adjust for several
years after an inflationary episode. Economists have tried to measure whether wage increases lag
price increases since the 1890s but have consistently found the relationship difficult to estimate.
Many people also dislike inflation because they feel it makes it easier for the government,
employers, financial institutions, and others to deceive them. Thus, over 70 percent of Shiller’s
respondents agreed that “One of the most important things I don’t like about inflation is that the
confusion caused by price changes enables people to play tricks on me, at my expense.” Thus,
some employers may “forget” to raise their employees’ wages as much as inflation thereby giving
There is evidence that people do get fooled, at least initially, about their real wages. Economists
Peter Diamond, Eldar Shafir, and Amos Tversky argue in their recent paper, “On Money
Illusion,” that people seem to base their sense of satisfaction on nominal earnings, rather than real
earnings. Similarly, Shiller found that over half of his respondents agreed with the statement that,
“I think that if my pay


I'm Morris!

Would you like to get a custom essay? How about receiving a customized one?

Check it out