Economics: Is Inflation really "Bad"?

The increase of overall level of prices is called inflation, duh. Although nowadays we assume inflation is natural, in the past there have been incidences of deflation, when prices fell. When the prices increase dramatically, it is called hyperinflation. 

In this chapter, we will view inflation as the value of money dropping rather than price level increasing. What determines the value of money? Supply and demand of course! The Federal Reserve sets the supply on the x-axis (vertical line) while the demand curve is curved. On the y-axes, the value of money from low to high and price level from high to low is depicted. It is important to recognize that in the long run, the overall level of prices adjusts to the level where demand equals supply of money. 

The effects of how price level/value of money is affected by changes in the supply is called the quantity of theory of money.

Nominal variables are measured in monetary units like dollars. Real variable is measured in physical units like bushels. This separation of two categories is called classical dichotomy. Although inflation makes price levels increase, it doesn't change the value of the physical values. The irrelevance of monetary changes for real variables is called monetary neutrality. 

Velocity of money describes how many times money changes hands. V (velocity) = Price level * Quantity of Output (real GDP) / Quantity of M. If we write P = price level, Y = real GDP, and M = quantity of M, then we write V = (P * Y)/M and M * V = P * Y. This last equation is called the quantity equation. Velocity typically remains stable.

Nominal interest rate corresponds closely with inflation since real interest rates remain constant. This is called the Fisher effect,

Alright so I've still been spending too much time writing my blogs so I'm going to quickly answer the topic of the blog. The general premise is that inflation isn't as harmful as people think it is, inflation is actually monetarily neutral and only changes price levels but not actually the production, employment, real wages, etc. and doesn't affect real variables. However, economists have identified several side effects of inflation that might be large enough to not be negligible. 

1. The Inflation Tax: a tax on people that already have money. When money is printed, the money you have in your pocket loses value.

2. The Shoeleather Cost: time/effort that people have to spend rushing to put money into banks to prevent the inflation tax. This is more notable during periods of hyperinflation.

3. Menu Costs: all costs associated with firms having to change prices, whether dealing with unhappy customers to replacing catalogs.

4. Relative-Price Variability and the Misallocation of Resources: since inflation is constantly happening, prices might not always reflect the laws of supply and demand and misallocate the economy's scarce resources. Consumer decisions are distorted.

5. Inflation-induced Tax Distortions: many lawmakers overlook inflation when writing tax laws. Thus, when there is inflation, the tax burden increases on income from savings and capital gains (selling something later for a higher price). This problem also occurs with income tax. 

6. Confusion and Inconvenience: inflation changes the unit of account and can confuse people.

7. Arbitrary Redistributions of Wealth: this one is a big one. Inflation makes it easier for debtors to pay off loans in the short run whereas deflation makes the investor benefit. This last point shows that low inflation means a more stable inflation rate, since there is less random distribution of wealth.