Money & BankingWhich do you think would be more harmful to the economy: an inflation that averages 5% per year and has a high standards deviation rate, or that of a 7% inflation that has a...
Which do you think would be more harmful to the economy: an inflation that averages 5% per year and has a high standards deviation rate, or that of a 7% inflation that has a standards deviation close to zero?
An inflation that averages 5% per year and has a high standard deviation would be more harmful than a higher inflation rate of 7% inflation but which is relatively constant. The former could see wide movements, for example inflation in one year could be at 2% and the next year spiral to 11%. This would make it very difficult for participants of the economy to take the required steps to counter inflation. Businesses would suffer and investors would have absolutely no idea where to invest their money.
There are too many variable to give a full answer. However, if I had to pick, I would say that inflation is the worst that can happen for two reasons. First, when inflation starts, it is hard to control. You would have to raise interest rates, and the Federal government is keeping rates low. Also real wages are not increasing. So, when inflation takes place, it will feel a lot worse.
Stability is the overriding concern when it comes to the economy. For businesses to plan and to manage risk effectively, they need to know what the future holds. The first situation you give creates a far more turbulent economy than the second situation, even though the rates are slightly lower, and as a result the last situation would be preferable.
The former would be worse. What an economy needs is certainty. Certainty allows businesses to plan. If they know what inflation will be, they will be able to plan for it. If they do not know what it will be, they won't. Therefore, the more uncertain scenario is more harmful to the economy.
I agree with the post above that says that certainty is very important to promoting economic growth. I've read over and over during the past few years that one reason the economy has not bounced back more quickly from the present recession is the enormous amount of uncertainty that now exists.
I too would say that while inflation is an economic challenge, it can be handled if it is a known, or expected, fact. If the deviation is low, then businesses and individuals can build inflation into their budgets and plan accordingly, to some degree.