Should Nations Learn to Live with Inflation?

24 Pages Posted: 2 Jul 2004 Last revised: 12 Sep 2010

See all articles by Stanley Fischer

Stanley Fischer

Bank of Israel; National Bureau of Economic Research (NBER); International Monetary Fund (IMF)

Lawrence H. Summers

Harvard University; National Bureau of Economic Research (NBER); Harvard University - Harvard Kennedy School (HKS)

Date Written: 1989

Abstract

It is often argued that the most important costs of inflation can be substantially mitigated by indexing reforms. Yet governments in moderate inflation countries have generally been very reluctant to promote institutional changes that would reduce the costs of inflation. Capital income continues to be taxed on a nominal basis, indexed bonds are a rarity, typical mortgage contracts keep nominal rather than real payments constant, and interest is not paid on required reserves. This paper examines the welfare consequences of inflation mitigation measures in the context of dynamic consistency theories of the determination of the inflation rate. Our general conclusion is that recognizing the effects of inflation mitigation measures on the choice of the inflation rate substantially undercuts the welfare case in their favor. It is easy to construct examples in which such measures actually reduce welfare. The case for indexing measures is strongest in settings where governments already have strong anti-inflation reputations, cannot precisely control the inflation rate, and can offset the effects of unanticipated inflation without reducing the costs of anticipated inflation. Conversely, the case for inflation mitigation measures is weakest where governments lack strong reputations, can control the inflation rate, and where indexing makes it easier to live with anticipated inflation.

Suggested Citation

Fischer, Stanley and Summers, Lawrence H., Should Nations Learn to Live with Inflation? (1989). NBER Working Paper No. w2815. Available at SSRN: https://ssrn.com/abstract=447229

Stanley Fischer (Contact Author)

Bank of Israel ( email )

P.O. Box 780
Jerusalem, 91907
Israel

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

International Monetary Fund (IMF) ( email )

700 19th Street NW
Washington, DC 20431
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Lawrence H. Summers

Harvard University ( email )

1875 Cambridge Street
Cambridge, MA 02138
United States
617-495-1502 (Phone)
617-495-8550 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Harvard University - Harvard Kennedy School (HKS) ( email )

79 John F. Kennedy Street
Cambridge, MA 02138
United States

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