Page 178 - Krugmans Economics for AP Text Book_Neat

level of prices in the United States was much higher than it was in 1969—but that, as
we’ve learned, didn’t matter. The inflation rate in the 2000s, however, was much lower
than in the 1970s—and that almost certainly made the economy richer than it would
have been if high inflation had continued.
Economists believe that high rates of inflation impose significant economic costs.
The most important of these costs are shoe -leather costs, menu costs, and unit -of -account
costs. We’ll discuss each in turn.
Shoe - Leather Costs People hold money—cash in their wallets and bank deposits on
which they can write checks—for convenience in making transactions. A high inflation
rate, however, discourages people from holding money, because the purchasing power
of the cash in your wallet and the funds in your bank account steadily erodes as the
overall level of prices rises. This leads people to search for ways to reduce the amount of
money they hold, often at considerable economic cost.
During the most famous of all inflations, the German
hyperinflation of 1921–1923, merchants employed runners
to take their cash to the bank many times a day to convert
Compassionate Eye Foundation/Siri Stafford/Digital resources—the time and labor of the runners—that could have
it into something that would hold its value, such as a sta-
ble foreign currency. In an effort to avoid having the pur-
chasing power of their money eroded, people used up valuable

been used productively elsewhere. During the German hy-
perinflation, so many banking transactions were taking
Vision/Getty Images
place that the number of employees at German banks
nearly quadrupled—from around 100,000 in 1913 to
375,000 in 1923. More recently, Brazil experienced hyper-
inflation during the early 1990s; during that episode, the
Brazilian banking sector grew so large that it accounted for 15% of GDP, more than
twice the size of the financial sector in the United States measured as a share of GDP.
The large increase in the Brazilian banking sector that was needed to cope with the
consequences of inflation represented a loss of real resources to its society.

fyi

Israel’s Experience with Inflation
It’s hard to see the costs of inflation clearly be- Banks responded by opening a lot of branches,
cause serious inflation is often associated with a costly business expense.
other problems that disrupt the economy and Second, although menu costs weren’t that
life in general, notably war or political instability visible to a visitor, what you could see were the
(or both). In the mid-1980s, however, Israel ex- efforts businesses made to minimize them. For
perienced a “clean” inflation: there was no war, example, restaurant menus often didn’t list
the government was stable, and there was Ricki Rosen/Corbis Saba prices. Instead, they listed numbers that you
order in the streets. Yet a series of policy errors had to multiply by another number, written on a
led to very high inflation, with prices often rising chalkboard and changed every day, to figure out
more than 10% a month. The shoe-leather costs of inflation in Israel: the price of a dish.
when the inflation rate hit 500% in 1985, peo-
As it happens, one of the authors spent a Finally, it was hard to make decisions be-
ple spent a lot of time in line at banks.
month visiting Tel Aviv University at the height of cause prices changed so much and so often. It
the inflation, so we can give a first - hand ac- out of accounts that provided high enough inter- was a common experience to walk out of a
count of the effects. est rates to offset inflation. People walked store because prices were 25% higher than at
First, the shoe - leather costs of inflation were around with very little cash in their wallets; they one’s usual shopping destination, only to dis-
substantial. At the time, Israelis spent a lot of had to go to the bank whenever they needed to cover that prices had just been increased 25%
time in lines at the bank, moving money in and make even a moderately large cash payment. there, too.

136 section 3 Measurement of Economic Performance