The Resource Cost Of Inflation

In addition to its possible redistribution of income, inflation imposes another cost upon society. To cope with inflation, we are forced to use up time and other resources as we go about our daily economic activities (shopping, selling, saving) that we could otherwise have devoted to productive activities. Thus, inflation imposes an opportunity cost on society as a whole and on each of its members:

When people must spend time and other resources coping with inflation, they pay an opportunity cost—they sacrifice the goods and services those resources could have produced instead.

Let's first consider the resources used up by consumers to cope with inflation. Suppose you shop for clothes twice a year. You've discovered that both The Gap and Banana Republic sell clothing of similar quality and have similar service, and you naturally want to shop at the one with the lower prices. If there is no inflation, your task is easy: You shop first at The Gap and then at Banana Republic; thereafter, you rely on your memory to determine which is less expensive.

With inflation, however, things are more difficult. Suppose you find that prices at Banana Republic are higher than you remember them to be at The Gap. It may be that Banana Republic is the more expensive store, or it may be that prices have risen at both stores. How can you tell? Only a trip back to The Gap will answer the question—a trip that will cost you extra time and trouble. If prices are rising very rapidly, you may have to visit both stores on the same day to be sure which one is cheaper. Now, multiply this time and trouble by all the different types of shopping you must do on a regular or occasional basis—for groceries, an apartment, a car, concert tickets, compact discs, restaurant meals, and more. Inflation can make you use up valuable time—time you could have spent earning income or enjoying leisure activities. True, if you shop for some of these items on the Internet, you can compare prices in less time, but not zero time. And most shopping is not done over the Internet.

Inflation also forces sellers to use up resources. First, remember that sellers of goods and services are also buyers of resources and intermediate goods. They, too, must do comparison shopping when there is inflation, and use up hired labor time in the process. Second, each time sellers raise prices, labor is needed to put new price tags on merchandise, to enter new prices into a computer scanning system, to update the HTML code on a web page, or to change the prices on advertising brochures, menus, and so on.

Finally, inflation makes us all use up resources managing our financial affairs. We'll try to keep our funds in accounts that pay high nominal interest rates, in order to preserve our purchasing power, and minimize what we keep as cash or in low-interest checking accounts. Of course, this means more frequent trips to the bank or the automatic teller machine, to transfer money into our checking accounts or get cash each time we need it.

All of these additional activities—inspecting prices at several stores or Web sites, changing price tags or price entries, going back and forth to the automatic teller machine—use up not only time, but other resources too, such as gasoline, paper, or the wear and tear on your computer. From society's point of view, these resources could have been used to produce other goods and services that we'd enjoy.

You may not have thought much about the resource cost of inflation, because in recent years, U.S. inflation has been so low—under 3 percent per year in the 1990s. Such a low rate of inflation is often called creeping inflation—from week to week http://

To learn more about the strengths and weaknesses of the CPI, read Allison Wallace and Brian Motley, "A Better CPI" (http://www.frbsf. org/econrsrch/wklyltr/wklytr99/ el99-05.html).

or month to month, the price level creeps up so slowly that we hardly notice the change. The cost of coping with creeping inflation is negligible.

But it has not always been this way. Three times during the last 50 years, we have had double-digit inflation—about 14 percent during 1947-48, 12 percent in 1974, and 13 percent during 1979 and 1980. Going back farther, the annual inflation rate reached almost 20 percent during World War I and rose above 25 percent during the Civil War.

And as serious as these episodes of American inflation have been, they pale in comparison to the experiences of other countries. In Germany in the early 1920s, the inflation rate hit thousands of percent per month. And more recently—in the late 1980s—several South American countries experienced inflation rates in excess of 1,000 percent annually. For a few weeks in 1990, Argentina's annual inflation rate even reached 400,000 percent! Under these conditions, the monetary system breaks down almost completely. Economic life is almost as difficult as in Chaotica.

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