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Explain The Impact Of Inflation On Economic Efficiency?

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Tariq Habib answered
Inflation impairs economic efficiency because it distorts price signals. In a low inflation economy, if the market price of a good rises, both buyers and sellers know that there has been an actual change in the supply and or demand conditions for that good, and they can react appropriately. For example, if the neighborhood supermarkets all boost their beef price by 50 percent, perceptive consumers know that its time to start eating more chickens. Similarly, if the prices of new computers fall by 90 percent, you may decide its time to turn in your old model.

By contrast, in a high inflation economy it's much harder to distinguish between changes in relative prices and changes in the overall price level. If inflation is running at 20 or 30 percent per month, stores change their prices so often that changes in relative prices get missed in the confusion.

Inflation also distorts the use of money. Currency is money that bears a zero nominal interest rate. If the inflation rate rises 0 to 10 percent annually, the real interest rate on currency falls from 0 to 10 percent per year. There is no way to correct this distortion.

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