The changing value requires that we correct for

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Unformatted text preview: ng of the year and high at the end when inflation has happened. Page 10 of 52 Jessica Gahtan Prof: Mokhles Hossain Macroeconomics ECON2000 Fall 2013 Taxes: inflation can alter an individual’s tax liability since the tax system does not take inflation into account. For example, capital gains on stock are taxed on the nominal gain, however inflation can make the real gain zero, making you pay taxes on it even though it had zero real gain. The same applies to interest- income taxes, since the tax system was designed for zero- inflation. Let t stand for the individual’s tax rate on interest income, so the after- tax real yield r is i(1 – t) – π. This represents a significant disincentive to save and invest. Living in a world with a changing price level: inconvenient because the ruler with which we measure economic transactions is changing length. The changing value requires that we correct for inflation when comparing dollar figures from different times. Also complicates financial planning. Costs of unexpected inflation Arbitrarily redistributes income: if inflation turns out to be higher than expected, the debtor wins and the creditor loses because the ex post real interest rate is smaller. If inflation is lower than expected, the creditor wins and the debtor loses because the ex post real interest rate is greater. The creditor is repaid with more valuable dollars. For example, fixed pensions; workers and firms agree on a fixed nominal pension when the worker retires. Higher than expected inflation can be extremely devastating when the pensioners purchasing power is reduced by so much. Possible benefit of inflation Some economists believe that a little bit of inflation – say, 2 percent – can be a good thing. Inflation “greases the wheels” of labour markets. Cuts in nominal wages are rare. A 2 percent wage cut with zero inflation is, in real terms, the same as a 3% raise in 5% inflation. Therefore this pleases workers, who always resist a drop in nominal wages but rarely in real wages. Hyperinflation is often defined as inflation that exceeds 50% per month. Costs: increases shoeleather cost since businesses devote time to cash management, taking time away from activities such as production and investment, the economy runs less efficiently. Increa...
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This test prep was uploaded on 03/28/2014 for the course ECON 2000 taught by Professor Henriques during the Fall '10 term at York University.

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