Why Should Economists Dislike Higher Inflation?

Why, exactly, is higher inflation so bad? That simple question stands as an embarrassment for the economics profession. We all feel that an inflation rate of 6.2% is undesirable, but we are not very good at explaining why.

It’s easy enough to use crude economic theory to show why inflation isn’t such a big deal. Money is what economists call “neutral,” or sometimes “super-neutral.” To oversimplify a bit, in the economic models a higher rate of price inflation will raise wages and prices in a broadly proportionate manner, leaving the outputs and employment patterns of the economy either unchanged or with only minor modifications.

Yet most economists persist in a negative view of higher inflation. One hypothesis is that inflation confuses people. Most people are not hyper-rational calculating machines, and they tend to see higher inflationary prices as representing real economic changes. So producers might see higher nominal demands for their goods and think they have suddenly become more popular with consumers, rather than merely being caught up in an inflationary spiral.

Still, under this scenario inflation doesn’t have to be bad. If producers increase their outputs and hire more labor, that tends to boost economies, not harm them. That is all the more true if there is some initial degree of output-restricting monopoly.

But what if producers eventually learn they are facing mere inflation and have to go back to their previous decisions? That would surely carry costs. Maybe, but the worst economic downturns involve virtually all sectors contracting at roughly the same time, rather than the main problem being a lot of churn and “to and fro.” Some of these switching costs might be real, but that doesn’t seem to account for why people dislike inflation so much. And in the current situation, the real “to and fro” costs are coming from waves of the pandemic, not from monetary policy.