The Costs of Inflation Revisited

Neoclassical treatments of inflation understate the costs associated with inflation, even at very low levels. A comparative institutions perspective that recognizes the epistemological properties of prices and the institutional process by which inflation takes place, reveals the costs of inflation to be both larger and more widespread than standard treatments suggest. This paper makes use of insights from Austrian economics, public choice theory, and the new institutional economics to argue that inflation imposes costs by undermining the coordinative properties of the price system. Not only are there the direct costs of increased economic error, but actors also divert resources away from direct want-satisfaction into attempts to either prevent or cope with the increased degree of uncertainty inflation imposes. These resource costs are best understood from a comparative institutions perspective, as traditional measures of economic well-being, such as GDP, cannot distinguish between exchanges that directly satisfy wants, and exchanges that are attempts to correct or prevent utility-diminishing activities. The analogy between these coping costs and rent-seeking behavior is explored. In addition, inflation imposes costs by undermining the coordinative properties of markets and inducing actors to, on the margin, prefer to seek wealth or allocate resources through the political process.