EffectsofInflation.pdf

Effects of Inflation Unanticipated Inflation in the Labor Market Unanticipated inflation has two main consequences in the labor market: ? Redistribution of income ? Departure from full employment Effects of Inflation Higher than anticipated inflation lowers the real wage rate and employers gain at the expense of workers. Lower than anticipated inflation raises the real wage rate and workers gain at the expense of employers. Higher than anticipated inflation lowers the real wage rate, increases the quantity of labor demanded, makes jobs easier to find, and lowers the unemployment rate. Lower than anticipated inflation raises the real wage rate, decreases the quantity of labor demanded, and increases the unemployment rate. Effects of Inflation Unanticipated Inflation in the Market for Financial Capital Unanticipated inflation has two main consequences in the market for financial capital: it redistributes income and results in too much or too little lending and borrowing. If the inflation rate is unexpectedly high, borrowers gain but lenders lose. If the inflation rate is unexpectedly low, lenders gain but borrowers lose. Effects of Inflation When the inflation rate is higher than anticipated, the real interest rate is lower than anticipated, and borrowers want to have borrowed more and lenders want to have loaned less. When the inflation rate is lower than anticipated, the real interest rate is higher than anticipated, and borrowers want to have borrowed less and lenders want to have loaned more. Effects of Inflation Forecasting Inflation To minimize the costs of incorrectly anticipating inflation, people form expectations about the inflation rate. A rational expectation is one based on all relevant information and is the most accurate forecast possible, although that does not mean it is always right; to the contrary, it will often be wrong. It does mean that the forecasts will not be systematic