From: kenr@orleans.storage.tandem.com (Ken Rose)
Subject: Re: Since no one is defending inflation, (
Reply-To: kenr@orleans.storage.tandem.com
Organization: Tandem Computers Inc.
Date: Fri, 22 Jan 1993 18:08:08 GMT

In article 1jngr2INNfq7@darkstar.UCSC.EDU, david@cats.ucsc.edu (David Michael Wright) writes:
>
>In article <1993Jan21.211928.8356@athena.mit.edu> cmk@athena.mit.edu (Charles M Kozierok) writes:
>
>|how is [inflation] good? it is rather simplistic to just look at the increasing
>|price of your house without also considering how the price of everything
>|else is also increasing, and the fact that the bottom tier of house
>|buyers is pushed out of the market.
>
>Unanticipated inflation is, in general, a good thing: if wages are
>sticky it gives you the opportunity to work if the real wage is
>reduced, it makes you economize on money balances so you invest more,
>it reduces debt and thereby makes it easier to invest, it gives a
>signal that the economy is improving (which it may be for the
>reasons above or not) and so boosts consumer confidence. Moderate inflation has
>nearly always been associated with rising output.


I beg to disagree here (that unanticipated inflation is, in general, good).

People and institutions can be categorized in two groups -- net monetary debtors
and net monetary creditors.  A net monetary debtor is someone who owes more
money than he owns.  For example, if you have a $150,000 mortgage and savings
of $10,000, you are a net monetary debtor to the tune of $140,000.

Unanticipated inflation rewards the net monetary debtor and punishes the net
monetary creditor.  The real value of the money owed by the net debtor erodes
with inflation, as does the debt held by the net creditor.  One gains, the
other loses.   Since on whole the amount of money owed equals the amount of
money loaned, the gains to one party are offset by losses to the other.  It`s
a zero sum game, and I find it hard to claim that inflation is therefore, in
general, a good thing.  It`s only a good thing if you happen to be a net debtor.

Take the '70s, for example.  If you took out a long-term loan for $60,000 and then
inflation tripled prices, you only had to pay back in real terms roughly 1/3 of
what you borrowed.  And if you were smart enough to have plunked that $60,000
into a home that merely appreciated enough to stay abreast of inflation, you
won big!  

However, if you were nearing retirement and plugged your savings into long-term
bonds or a savings account, you lost 2/3 of your nest egg due to inflation.  The
debacle of the S & L's started in large measure because they had long term loans
at fixed pre-inflation interest rates, while depositors had short-term accounts 
they emptied in search of higher returns in money-market accounts and the like.

Not only is unanticipated inflation a zero sum game, it imposes additional costs
through uncertainty.  People become worried about inflation returning again at
some point in the future; this drives up the interest rate that must be paid on
long-term debt.  In practical terms, this means your local government has to pay
more to finance projects with bonds, as does a corporation issuing bonds. 
Unanticipated inflation also distorts market incentives (although I`ve gotten
the idea that many readers of sci.econ don't believe prices, supply, demand, etc.
have much to do with directing the economy).  When prices for a resource rise,
it generally means demand has increased (absent fluctuations in the supply); firms
respond by producing more output, looking for ways to conserve the resource,
develop substitutes, etc.  But if the rise in prices is merely due to unanticipated
inflation, all these responses were in error.
____________________________________________________________________
Ken Rose    (kenr@storage.tandem.com)
The Usual Disclaimer:  Any opinions expressed above are mine alone, not
those of my employer (who is kind enough to allow me Usenet access).

Newsgroups: sci.econ,soc.culture.usa,soc.culture.japan,soc.culture.british,soc.culture.canada