Another Attempt to Quantify the Benefits of Reducing Inflation

Abstract

This article estimates the benefits of reducing U.S. inflation below its current level when the government simultaneously raises another distortionary tax. Other researchers have suggested that reducing inflation would have fairly large benefits—from 1 to 3 percent of gross domestic product. But that result depends on the unrealistic assumption that the government would replace inflation with a lump-sum tax, one which does not affect people's incentives. If, instead, inflation is replaced with an increase in the labor income tax, then the welfare gains that can be expected from reducing inflation below its current level are much smaller—from one-third to one-half of 1 percent of gross domestic product.

---