The Review of Austrian Economics, 16:1, 77–95, 2003.
2003 Kluwer Academic Publishers. Manufactured in The Netherlands.
The Costs of Inﬂation Revisited
STEVEN HORWITZ email@example.com
Department of Economics, St. Lawrence University, Canton, NY 13617
Abstract. Neoclassical treatments of inﬂation understate the costs associated with inﬂation, even at very low
levels. A comparative institutions perspective that recognizes the epistemological properties of prices and the
institutional process by which inﬂation takes place, reveals the costs of inﬂation to be both larger and more
widespread than standard treatments suggest. This paper makes use of insights from Austrian economics, public
choice theory, and the new institutional economics to argue that inﬂation imposes costs by undermining the
coordinative properties of the price system. Not only are there the direct costs of increased economic error, but
actors also divert resources away from direct want-satisfaction into attempts to either prevent or cope with the
increased degree of uncertainty inﬂation imposes. These resource costs are best understood from a comparative
institutions perspective, as traditional measures of economic well-being, such as GDP, cannot distinguish between
exchanges that directly satisfy wants, and exchanges that are attempts to correct or prevent utility-diminishing
activities. The analogy between these coping costs and rent-seeking behavior is explored. In addition, inﬂation
imposes costs by undermining the coordinative properties of markets and inducing actors to, on the margin, prefer
to seek wealth or allocate resources through the political process.
Key Words: inﬂation, Austrian school of economics, economic growth
JEL classiﬁcation: B53, E31.
As inﬂation rates have continued to fall both in the US and world-wide, economic analyses
of inﬂation have shifted from focusing on the problems associated with high levels of
inﬂation to exploring the costs and beneﬁts of reducing inﬂation from its current low level
toward zero. It is often argued that the beneﬁts from squeezing out the last few percentage
points of inﬂation might well be less than the costs of doing so, in terms of foregone output
and/or employment along some Phillips curve. This literature has carefully attempted to
specify the nature of those costs and beneﬁts, as well as provide some indication of the
empirical magnitudes involved.
These studies have come up with a variety of results, both
theoretically and empirically, with no clear consensus on whether further attempts to reduce
inﬂation are justiﬁed on welfare grounds.
The difﬁculty faced by these studies is that they center the costs of inﬂation around
the way inﬂation taxes money balances, as has been the practice for many years (since
Bailey (1956) at least). This perspective is overly narrow, and changes in the theoretical
landscape of economics in the last couple of decades make a re-examination of the costs
of inﬂation a worthwhile undertaking. In particular, the maturation of public choice eco-
nomics, the growth of New Institutionalism, and the revival of the Austrian school have all
prompted more careful analyses of the operation of both market and political institutions