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Some Costs and Benefits of Price Stability in the United Kingdom

In: The Costs and Benefits of Price Stability

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  • Hasan Bakhshi
  • Andrew Haldane
  • Neal Hatch

Abstract

In a previous attempt to articulate the costs of inflation (Leigh-Pemberton (1992)), the Bank of England outlined the following costs of a fully-anticipated inflation: - the cost of economising on real money balances -- so-called shoe-leather' effects; - the costs of operating a less-than-perfectly indexed tax system; - the costs of front-end loading' of nominal debt contracts; - the cost of constantly revising price lists -- so called menu costs' Feldstein (1996) quantified the first two of these costs when moving from 2% inflation to price stability in the U.S. Feldstein concluded that the permanent welfare gains through these two channels -- suitably discounted -- alone exceeded the transient costs of doing so. This paper aims to replicate Feldstein's analysis for the U.K. Welfare effects are quantified using deadweight loss analysis familiar from public finance economics. Because inflation exacerbates tax distortions that exist even without inflation, the welfare costs are trapezoids rather than the usual triangles, or, alternatively, first-order rather than second-order losses. We find that the welfare gains from moving to price stability through the two channels identified above are lower in

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  • Martin Feldstein, 1999. "The Costs and Benefits of Price Stability," NBER Books, National Bureau of Economic Research, Inc, number feld99-1, October.
    This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number 7773.

    Handle: RePEc:nbr:nberch:7773

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    1. Robert J. Barro, 1995. "Inflation and Economic Growth," NBER Working Papers 5326, National Bureau of Economic Research, Inc.
    2. George A. Akerlof & William R. Dickens & George L. Perry, 1996. "The Macroeconomics of Low Inflation," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 27(1), pages 1-76.
    3. Laurence Ball, 1993. "What determines the sacrifice ratio?," Working Papers 93-21, Federal Reserve Bank of Philadelphia.
    4. Alan S. Blinder, 1991. "Why are Prices Sticky? Preliminary Results from an Interview Study," NBER Working Papers 3646, National Bureau of Economic Research, Inc.
    5. Tamim Bayoumi, 1992. "Financial Deregulation and Household Saving," Bank of England working papers 5, Bank of England.
    6. Boskin, Michael J, 1978. "Taxation, Saving, and the Rate of Interest," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 86(2), pages S3-27, April.
    7. Steve Bond & Michael Devereux & Harald Freeman, 1990. "Inflation non-neutralities in the UK corporation tax," Fiscal Studies, Institute for Fiscal Studies, Institute for Fiscal Studies, vol. 11(4), pages 21-29, November.
    8. Steve Bond & Kevin Denny & Michael Devereux, 1993. "Capital allowances and the impact of corporation tax on investment in the UK," Fiscal Studies, Institute for Fiscal Studies, Institute for Fiscal Studies, vol. 14(2), pages 1-14, May.
    9. Orazio Attanasio, 1994. "Personal Saving in the United States," NBER Chapters, in: International Comparisons of Household Saving, pages 57-124 National Bureau of Economic Research, Inc.
    10. Laurence M. Ball, 1997. "Disinflation and the NAIRU," NBER Chapters, in: Reducing Inflation: Motivation and Strategy, pages 167-194 National Bureau of Economic Research, Inc.
    11. Akerlof, George A & Yellen, Janet L, 1985. "A Near-rational Model of the Business Cycle, with Wage and Price Intertia," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 100(5), pages 823-38, Supp..
    12. Charles L. Ballard & Don Fullerton, 1993. "Distortionary Taxes and the Provision of Public Goods," NBER Working Papers 3506, National Bureau of Economic Research, Inc.
    13. Breedon, F J & Fisher, P G, 1996. "M0: Causes and Consequences," The Manchester School of Economic & Social Studies, University of Manchester, University of Manchester, vol. 64(4), pages 371-87, December.
    14. Blundell, Richard & Bond, Stephen & Devereux, Michael & Schiantarelli, Fabio, 1992. "Investment and Tobin's Q: Evidence from company panel data," Journal of Econometrics, Elsevier, Elsevier, vol. 51(1-2), pages 233-257.
    15. Ballard, Charles L & Shoven, John B & Whalley, John, 1985. "General Equilibrium Computations of the Marginal Welfare Costs of Taxes in the United States," American Economic Review, American Economic Association, American Economic Association, vol. 75(1), pages 128-38, March.
    16. James Banks & Richard Blundell, 1993. "Household saving behaviour in the UK," IFS Working Papers, Institute for Fiscal Studies W93/05, Institute for Fiscal Studies.
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    Cited by:
    1. Nicoletta Batini & Andrew Haldane, 1999. "Forward-Looking Rules for Monetary Policy," NBER Chapters, in: Monetary Policy Rules, pages 157-202 National Bureau of Economic Research, Inc.
    2. Leo Bonato, 1998. "The benefits of price stability: some estimates for New Zealand," Reserve Bank of New Zealand Bulletin, Reserve Bank of New Zealand, Reserve Bank of New Zealand, vol. 61, September.
    3. Jacek Cukrowski & George Kavelashiwli, 2002. "Inflation and Adjustment of Relative Prices in Georgia," CASE-CEU Working Papers 0042, CASE-Center for Social and Economic Research.
    4. Hasan Bakhshi & Ben Martin & Tony Yates, 2002. "How uncertain are the welfare costs of inflation?," Bank of England working papers 152, Bank of England.
    5. Mark A. Wynne, 2008. "How should central banks define price stability?," Globalization and Monetary Policy Institute Working Paper, Federal Reserve Bank of Dallas 08, Federal Reserve Bank of Dallas.
    6. Simon Hall & Mark Walsh & Anthony Yates, 1997. "How do UK companies set prices?," Bank of England working papers 67, Bank of England.
    7. Simon Hall & Anthony Yates, 1998. "Are there downward nominal rigidities in product markets?," Bank of England working papers 80, Bank of England.

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