Thursday, July 22, 2010

A Brief Note on Inflation

I'm amused by the discussion between Mark Wallace and LeftOutside at LibCon about inflation, naturally my insticts are with LeftOutside on this one, but before I go on I thought I might point out a well known study on inflation by Robert Barro. Robert Barro is the man who came up with the modern version of what we call Ricardian Equivalence (the idea that an increase in government spending will lead to an increase of private saving in anticipation of future taxes), and hardly someone we could call an inflation dove. Here's the abstact of his paper:
Data for around 100 countries from 1960 to 1990 are used to assess the effects of inflation on economic performance. If a number of country characteristics are held constant, then regression results indicate that the impact effects from an increase in average inflation by 10 percentage points per year are a reduction of the growth rate of real per capita GDP by 0.2-0.3 percentage points per year and a decrease in the ratio of investment to GDP by 0.4-0.6 percentage points. Since the statistical procedures use plausible instruments for inflation, there is some reason to believe that these relations reflect causal influences from inflation to growth and investment. However, statistically significant results emerge only when high- inflation experiences are included in the sample. Although the adverse influence of inflation on growth looks small, the long-term effects on standards of living are substantial. For example, a shift in monetary policy that raises the long-term average inflation rate by 10 percentage points per year is estimated to lower the level of real GDP after 30 years by 4-7%, more than enough to justify a strong interest in price stability.

So an empirical study indicates that the effect of a 10% increase in inflation will lead to a loss of 4-7% of GDP over 30 years. That kind of number is so small to be insignificant, and that's for a 10% increase in inflation, the difference between a 2% and 5% would be far harder to judge.

The point I'd like to make from this is mainly to point out that Wallace's main claim that inflation destroys lives doesn't really add up, if there was a genuine negative effect from inflation it would be reflected in the GDP growth figures, since it isn't we can't really draw that conclusion. We can of course say that there is likely to be some level of redistribution from inflation, but there's not really any discernible effect on the nation's overall wealth.

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