Aggregate losses from inflation
Let's sum up. What are the cumulative losses from inflation for the economy?
Is it possible to find the optimal rate of inflation?
The American economist Milton Friedman suggested that the optimal rate of inflation should be such that the marginal cost of inflation for society is equal to the marginal cost of inflation for private agents.
The optimal result from the point of view of society as a whole is the situation when the marginal costs of inflation are zero. For private agents, the marginal costs of inflation are determined by the price of the loss of the value of a monetary unit - the nominal interest rate:
where MC S - the marginal costs of society; MS P - private marginal costs.
Or , where r - is the real rate of interest.
Optimal inflation is actually a deflation, a decrease in prices with a rate equal to the real interest rate or real capital productivity.
If the current inflation differs from the optimal one, the society bears losses. To estimate the overall losses from inflation, we use the graph of the demand function for money (Figure 12.9)
Take as the reference point the level of optimal, according to Fridman, inflation. Where r = -π, there is an optimal demand for money, the optimal amount of money in the economy t *. The area under the demand line for money in this case is a surplus of consumers - the aggregate benefit of households and firms from the availability of money.
The presence of inflation in the economy leads to an increase in the nominal interest rate, say, to the level i 1 = r + π1. Demand for money is reduced to the level of t 1. Inflationary effects consist of three values, shown in the figure as dark areas.
The area of triangle 1 characterizes the loss of consumer surplus of money holders. Households and firms are forced to reduce their monetary assets, as the price of money increases. Thus, they are underpaying the benefits of liquidity, acquisitions related to ease of circulation of money, and are forced to seek money substitutes.
Fig. 12.9. Inflation losses
The area of rectangle 2 shows the amount of losses of the manufacturer's surplus (central bank) - a shortage of income from seignorage, which is caused by a reduction in demand for money. If there was no inflation and the nominal interest rate would be equal to the real productivity of capital ( i 0 = r ), the seigniorage income would be SE 0 = i 0 • t 0.
The values of 1 + 2 (the sum of the areas designated as 1 and 2) constitute net losses from inflation. This amount of potential acquisitions does not end up with anyone. Economic agents reduce the demand for money. The central bank receives less revenue from printing money.
The area of rectangle 3 is the benefit of inflation for the money provider. This is income from seignorage, caused by inflation.
Empirical studies of inflationary losses use the demand function for Lucas's money:
For example, for the US, the parameters of this function are: β = 0,27; a = 7.
For i = 6%; π = 4%, the net loss from inflation is DWL n = 0.3% of the country's GDP.
Other estimates of net inflation losses include the following studies:
1) Coley and Hansen (1991) showed that at π = 10%, the net loss from inflation is equal to DWL n < strong> = 0.6% of US GDP;
2) when assessing inflationary losses in the EU countries in the 1990s. on average, with π = 10%, the net loss was DWL n = 0.1-0.3% of the EU GDP;3) the researcher Bailey (Baily) in 1956 calculated that with hyperinflation, net losses increase to DVL π = 30% of US GDP.
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