The benefits of price stability : some estimates for New Zealand
Inflation is widely believed to undermine the performance of the economies that suffer from it. The reasons why inflation impairs economic performance are well known: it causes uncertainty, distorts the working of the price mechanism for allocating resources, and increases the costs of doing business because the effect of inflation has to be factored into business contracts and transactions. But empirical evidence to support these propositions generally is not strong, at least not for low to moderate inflation rates. However, recent work by Martin Feldstein, of Harvard University, suggests that the costs of inflation may be significant even at low rates. He focuses on the way in which inflation distorts the tax system and how this adds to what economists call the “dead-weight cost” of taxes. This article outlines the nature of those dead-weight costs and provides some estimates of their magnitude in New Zealand.