TY - JOUR
AU - Feldstein, Martin
TI - The Costs and Benefits of Going from Low Inflation to Price Stability
JF - National Bureau of Economic Research Working Paper Series
VL - No. 5469
PY - 1996
Y2 - February 1996
DO - 10.3386/w5469
UR - http://www.nber.org/papers/w5469
L1 - http://www.nber.org/papers/w5469.pdf
N1 - Author contact info:
Martin S. Feldstein
President Emeritus
NBER 1050
Massachusetts Avenue
Cambridge, MA 02138-5398
Tel: 617/868-3905
E-Mail: msfeldst@nber.org
M1 - published as Martin S. Feldstein. "The Costs and Benefits of Going from Low Inflation to Price Stability," in Christina D. Romer and David H. Romer, Editors, "Reducing Inflation: Motivation and Strategy" University of Chicago Press (1997)
AB - This paper evaluates the welfare gain from achieving price stability and compares it to the cost of the transition. In calculating the gain from price stability, the paper emphasizes the distortions caused by the interaction of inflation and capital income taxes. Because inflation exacerbates the tax distortions that would exist even with price stability, the annual deadweight loss of a two percent inflation rate is a surprisingly large one percent of GDP. Since the real gain from shifting to price stability grows in perpetuity at the rate of growth of GDP, its present value is a substantial multiple of this annual gain. Discounting the annual gains at the rate that investors require for risky equity investments (i.e., at the 5.1 percent real net-of-tax rate of return on the Standard and Poors portfolio of equities from 1970 to 1994) implies a present value gain equal to more than 35 percent of the initial level of GDP. Since the estimated cost of shifting from two percent inflation to price stability is about five percent of GDP, the gain substantially outweighs the cost of transition.
ER -