The Case for Zero Inflation - Inflation Distorts Nominal Prices, Socially Inefficient Institutions, and Economic Growth

Sep 21, 2026

Uploaded by Riley

The Economic Commentary argues that monetary policy should focus on completely eliminating long-run inflation and stabilizing the price level, treating temporary unforeseen deviations as temporary. It explains how inflation adds noise that distorts nominal prices, complicates comparisons across time, and reduces efficiency and economic opportunities. It further contends inflation fosters socially inefficient financial institutions and increases tax-related distortions, lowering long-term economic growth.

LanguageEnglish

CategoryResearch & Report

FormatPDF

Pages5

Reading Time13 min

AccessFree to download

Inflation Distorts Nominal Prices

Inflation Leads to Socially Inefficient Institutions

Inflation Is Costly When It Interacts with the Tax System

Inflation Reduces Economic Growth

# The Case forZero Inflation by William T.Gavin and Alan C.Stockman Few people claim to lie infaion.Yet few people can intelligentlyexplain why they dislike it.Eveneconomists frequently find it hard toexplain why inflation is bad,espe-cially if the inflation is fullyanticipated. Indeed,some economists argue that alow level of inflation is desirable.Others argue that inflation would beeliminated in an ideal world but thatthe short-run costs of eliminatinginflation are so high that the FederalReserve's monetary policy should aiminstead at maintaining the currentlevel of inflation or at achieving someother goal. This Economic Commentary contends that monetary policy shouldaim at completely eliminating long·run inflation.We specifically explainhow society could benefit if monetarypolicy were directed toward producing a stable price level,making tem-porary any unforeseen deviationsfrom this long-run target. eCONOMICCOMMCNTORY ■ Inflation Distorts Nominal PricesInflation adds "noise,"or distortion,to nominal pricesPeople must taxtheir memories and powers of calcu-lation to compare prices of goods atdifferent periods of time.Difficultieswith accurate price comparisons leadto economic inefficiencies.Inflationthereby limits the economic oppor-tunities for our society. This problem is particularly severewhen inflation is highly variable orhighly unpredictable.Unpredictableinflation causes inefficiencies becausepeople find it difficult to tell whethera price is high because of inflation orfor some other reason,such as highdemand or scarce supply.Variableinflation,even ifpredictable,compli-cates the calculations that peoplemust make to compare prices at dif-ferent times. This cost of inflation is importanteven for low rates of inflation,because the costs of accurately per-forming these calculations do notdepend very much on the level ofinflation.When long-term inflation is The authors argue that a monetarypolicy of zero inflation would benefitsociety by eliminating price distor-tion,increasing economic growth,adding liquidity to the economy,andreducing uncertainty associated withprice-level drift. eliminated and the price level is sta-bilized,however,people no longerneed to perform these calculations.Inefficiencies are reduced,and eco-nomic opportunities are maximized ■ Inflation Leads to SociallyInefficient InstitutionsInflation creates potential financiallosses for holders of money and otherassets denominated in dollars.Toavoid these private losses,marketsadjust by creating financial institu-tions and instruments that would beunprofitable in the absence of inflation.An obvious example is the financial“advice”industry that isconcerned with protecting invest-ments from inflation risk. Specific markets have been created totrade futures contracts in foreignexchange and interest rates.Therewas also a brief period in which thefinancial markettraded futures in thegovemment's reported level of theConsumer Price Index.This marketfolded as the inflation rate declinedin the 1980s.! The creation and maintenance ofthese institutions is socially inefficient.The resources used in themcould be better devoted to creatingproducts and services that peopledesire in an environment ofzeroinflation.The costs incurred in minimizing private losses from inflationare greatest when inflation is veryhigh or very unpredictable.Butimportant costs may still be presenteven at low and stable inflation rates. ■ Inflation Is Costly WhenIt Interacts with the Tax SystemInflation raises economic distortionsassociated with the existing tax system because taxes on the return tocapital are not adjusted for inflation.Arecent study estimated that the cost of10 percent inflation from this sourcealone is(as a rough order of magni-tude)about 0.7 percent of grossnationa product(GNP)each year,and possibly as high as 2 to 3 percentof GNP each year.² In addition,inflation raises othereconomic distortions by interactingwith the current tax system to alterth

FAQs

What is the core policy recommendation of the commentary?

Monetary policy should aim at completely eliminating long-run inflation by producing a stable price level.

How does inflation affect comparisons of prices over time?

Inflation adds noise to nominal prices, forcing people to rely on memory and calculation to compare goods across periods, which creates inefficiencies.

Why does inflation lead to socially inefficient institutions?

Inflation creates potential financial losses for money and dollar-denominated assets, prompting markets to create instruments and industries that protect against inflation risk, even though maintaining them is socially inefficient.

How does inflation interact with the tax system and affect the economy?

Because taxes on returns to capital are not adjusted for inflation, inflation raises economic distortions in asset allocation, debt versus equity choices, and asset life decisions, increasing costs even when inflation is low and fully anticipated.

Sep 21, 2026

Uploaded by Riley