Question

explain how costly is inflation,and how costly is reducing inflation?

Answer 1

In order to decide whether to target inflation and reduce it it is important to compare potential costs of inflation and costs of reducing inflation. The costs of inflation are the following: reduced international competitiveness, confusion among economic agents, the so-called menu costs and shoe leather costs and income redistribution, etc. Generally, inflation leads to devaluation of a national currency and falling wealth of citizens. The costs of reducing inflation are associated with higher interest rates and exapanditures on appropriate fiscal and monetary policy. In the end, the aggregate demand curve moves to the left. A government has to compare these both groups of costs for the purpose of defining the most appropriate and effective macroeconomic policy.