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Ideas de Peso | Disinflation and Growth

We invite you to read the new article on Ideas de Peso, a blog where economists working in the BCRA share their opinions:

There are many ways of reducing the inflation rate, which impacts positively on economic growth in the long term. One of the most significant ones is to reduce uncertainty. Any economic decision entails time. Let’s think, for example, about a lease agreement or about the demand for a mortgage loan. Naturally, the longer it takes to make an economic decision, the greater the uncertainty about its results will be. In inflationary contexts, such uncertainty is exacerbated. This is so due to the fact that in economies undergoing inflationary processes there is a rise in the spread of relative prices. Therefore, the assessment of costs related to the replenishment of a specific good or the evolution of costs of a certain production process, among other issues, become particularly blurred and, consequently, so does economic decision taking. Consequently, many decisions on medium- and long-term issues—specially, long-term credit and investment—are eventually not taken in inflationary contexts. In other words, high inflation shortens the contractual economy structure adversely affecting the long-term growth rate.

Now, the positive effects of disinflation on medium- and long-term economy are evident, but how does the reduction of the inflation rate affect the level of activity in the short term. This is actually a frequent question. Redistributive effects are then an important channel through which a lower inflation rate has an expansionary outcome in the short term. Lower income households have fewer chances to protect their funds from the natural loss of purchasing power stemming from a high inflation rate. In other words, the impact of the inflationary tax is higher on low income deciles. Thus, a reduced inflation rate triggers a purchasing power gain for households having a higher marginal propensity to consume, bringing about an expansionary impact on demand.

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April 20, 2017

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