Thursday, December 9, AD 2010
One argument commonly made by inflation hawks is that inflation is bad because it is a tax on savers. The idea being that since inflation erodes the purchasing power of a dollar, those who keep their money in a savings account will end up being able to buy less with that money down the road if there is inflation than if there is not. There is an element of truth to this idea, though if inflation is expected there are ways to deal with the problem, such as offering higher interest rates for savings accounts.
A propos of David’s post earlier to day, however, it occurs to me that there is a flip side to the inflation taxes savings argument, namely that disinflation (i.e. lower than expected inflation) functions as a tax on the unemployed. When a certain amount of inflation is expected over the coming years, this ends up getting built into people’s wage demands, contracts, loans, etc. If inflation is approximately 2-3% a year for several decades, then people will come to expect a raise of at least 2-3% a year to cover the increase in the cost of living, and they will get upset if this doesn’t happen, even if inflation is significantly below 2-3% (on election day I met a man who was angry he had been denied a cost of living raise in his Social Security for 2009, even though there was deflation that year).
If expected inflation doesn’t appear, there won’t be enough money for businesses to pay their workers and will have to cut either wages or employment. But since workers hate nominal wage cuts (even where these don’t translate into real wage cuts), employers tend to respond to this situation by laying people off rather than spreading the pain around. The result is that during inflationary or disinflationary periods real wages tend to increase (since prices are falling while wages remain constant in nominal terms) and so does unemployment. Functionally this acts as a kind of wealth transfer from the unemployed to those who still have jobs. Thus, tight money is a tax on the unemployed.