<p>Money is produced at zero social cost but held at a positive private cost (because to hold money you must forgo holding other assets).  Therefore there is a positive externality from holding money, which means that the usual arguments for subsidizing it apply.  This makes the optimal rate of inflation negative (because inflation is a tax on holding money).  In fact if you add a few details to the above argument, it's easy to see that the optimal rate of inflation is minus the real rate of interest.</p>

<p>On the other hand, funding the government is likely to require departing from an optimal tax system in which everything is taxed (or subsidized) according to the externalities it creates.  Presumably the optimal departure entails higher taxes on most things, including money holding, which means that the optimal inflation rate should be somewhere north of $-r$.  Whether it's north of zero is less clear.</p>

CC BY-SA 3.0
2015-08-26T12:19:58.740Z
https://en.wikipedia.org/wiki/Friedman_rule
suriv
CC BY-SA 4.0
2021-02-20T05:20:41.757Z
@KennyLJ:  First, Coase certainly did not refute the usual arguments for taxing/subsidizing when there are externalities.  What he did was forcibly drive home the point that these arguments are sometimes outweighed by counter-arguments.  But the usual arguments certainly still apply.  (By analogy:  A good reason for me to buy a car is that it will shorten my morning commute.  A good reason not to is that I'll have to pay for a garage space.  The second reason might outweigh the first, but it does not invalidate it.)
Steven Landsburg
CC BY-SA 4.0
2021-02-20T05:21:41.090Z
@KennyLJ:  Second, once you've decided to subsidize money, the obvious way to do it is via deflation (so that money gains in value as you hold it).  What alternative do you envision?
Steven Landsburg
CC BY-SA 3.0
2015-05-31T01:09:29.843Z
Perhaps it is late, perhaps I'm slow. What exactly is the positive externality?
FooBar
CC BY-SA 3.0
2015-05-31T02:50:30.260Z
@FooBar:  There are two ways to see it.  First, there has to be an externality because the private and social costs are not equal.  The other way to see it is this:  Every time you choose to hold another dollar (instead of spending it), the price level falls, which increases the value of everyone else's money.
Steven Landsburg
CC BY-SA 3.0
2015-06-01T17:28:38.697Z
I'm a little mystified by the downvote....
Steven Landsburg
CC BY-SA 3.0
2015-05-31T00:15:38.323Z
2015-05-31T00:15:38.323Z
Steven Landsburg
<ol>
<li><p>A little inflation is better than zero inflation (or deflation),
because <strong>wages are "sticky"</strong> - they don't usually get adjusted
downward.</p>

<p>If a company is facing a year that is a bit worse than the previous
year due to small fluctuations in demand, wages should actually be
decreased. Companies typically don't cut wages though, so they might
even choose to let go of some of their staff. Now, if there is 2%
inflation and wages remain flat in nominal terms (nobody is getting
a raise), wages will be down 2% in real terms. So the company is
better able to cope with the slump in demand (its real costs are
lower) and it might not have to let staff go.</p></li>
<li><p>Moderate inflation also makes it possible to have <strong>negative real
interest rates</strong>. This gives central banks more flexibility to
stimulate the economy.</p>

<p>Real interest rate = Nominal interest rate - Inflation</p>

<p>If inflation is zero and the nominal interest rate is zero, the real
interest rate will be zero and the central bank won't be able to
make interest rates go any lower (assuming nominal interest rates
can't be negative). However, if inflation is say 2%, if the central
bank sets the nominal interest rate to zero, the real interest rate
will be -2%, giving a significant stimulus to the economy.</p></li>
<li><p>In general, moderate inflation also <strong>helps keep the economy going</strong>. If
there is inflation and consumers or companies sit on cash, their
holdings are being devalued in real terms. This gives them an
incentive to spend and invest instead of hoarding cash.</p></li>
</ol>

CC BY-SA 4.0
2018-08-02T18:05:15.443Z
"Real interest rate = Nominal interest rate - Inflation" This is a close approximation for small values, but the real formula is real interest rate = (1+nominal interest rate)/(1+inflation). For instance, if the nominal interest rate is 50%, and inflation is 100%, then after one year you will have nominal dollars equal to 150% of your starting dollars, which will be worth 75% of your starting dollars.
Acccumulation
CC BY-SA 3.0
2017-08-29T14:34:44.303Z
2017-08-29T14:34:44.303Z
M3RS
<p>In the ECB's press conference of October 22, Draghi and his vice-president responded to the question of why the ECB is fighting low inflation so fiercely. Their answer provides a nice overview of why a low level of inflation is desired, and therefore should answer your question. </p>

<p>The following were their main arguments:</p>

<ul>
<li><p>low deflation is to be avoided because it increases the real value of debt and leads to costly debt servicing;</p></li>
<li><p>measurement of inflation tends to be exaggerated by most price indices, therefore, targetting zero-inflation would imply deflation. This justifies why the inflation target should be above zero;</p></li>
<li><p>with low or negative inflation, real interest rates may be too high to reach full employment;</p></li>
<li><p>generally, central banks want to avoid deflation. The vice-president refers at this point to "real deflation" in contrast to "having negative inflation for a few months". This situation of "real deflation" should certainly be avoided, first, because of nominal rigidity in wages, and second, because it will lead to postponing consumption.</p></li>
</ul>

<p>The transcript of the press conference can be found here: <a href="https://www.ecb.europa.eu/press/pressconf/2015/html/is151022.en.html" rel="noreferrer">https://www.ecb.europa.eu/press/pressconf/2015/html/is151022.en.html</a></p>

CC BY-SA 4.0
2016-01-07T21:19:59.333Z
2018-12-30T05:26:08.587Z
2018-12-30T05:26:08.587Z
Wecon
<p>Related to your question, most of the CBs target an inflation rate near 2%.
Laurence Ball argues in his paper that targeting 4% could be better and his arguments are solid in my opinion.
<a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2468019" rel="nofollow noreferrer">https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2468019</a></p>

<p>It became in a sense a reserve engineering for your answer but I think the paper will be beneficial to show the relationship between inflation and policymaker's tools and to see undesirability of zero inflation.</p>

CC BY-SA 3.0
2017-08-13T15:01:37.130Z
"Most central banks" - you mean the Eurozone and the US. This target was mainly pushed by Germany into the rules of the Eurozone. Germany has been for many years inflation averse, since their hyperinflation crisis in the 1930's.
JoaoBotelho
CC BY-SA 3.0
2017-05-18T01:17:57.970Z
2017-05-18T01:17:57.970Z
John Stern
<p>The optimal level of inflation is very debated with unclear answers. There are many reasons, and a great answer would be very long. It should also distinguish between expected inflation and surprises.</p>
<p>I'm not going to do any of this, but giving you three reasons for a desirable positive level of inflation. This list is of course incomplete, also there are many reasons against too high inflation.</p>
<h3>Downward-rigidity of wages</h3>
<p>It is really unclear to economists why it is happening, but nominal wages seem to be downward rigid. It appears to be a behavioral thing (and might not be true at all, see <a href="https://ideas.repec.org/a/eee/moneco/v3y1977i3p305-316.html" rel="nofollow noreferrer">Barro (1977)</a>), but it appears that in crises, once presented with the choice of more firings or reduction of wages, most firms/workers decide to not cut wages but rather respond to the slump with increased separations.</p>
<p>To the extent that we believe this lack of reduction in wages is suboptimal, the central bank can enforce a reduction in real wages through increased inflation rates, and thus preventing separations to some extent.</p>
<h3>Redistribution</h3>
<p>This argument is based on Keynesian theory. Keynes claimed that the marginal propensity to consume out of income is smaller for rich households (and indeed, we do find this in the data  to some extent). <strong>Unexpected</strong> inflation is similar to redistribution from creditors to borrowers, as long as debt contracts are not indexed to inflation.</p>
<p>To the extent that poor people consume more out of this unexpected wealth shock and than rich people decrease their consumption, this redistribution will lead to an increase in aggregate consumption.</p>
<h3>Room to cutback interest rates</h3>
<p>This argument was most prominently brought forward by Krugman around 2008. In recessions, you want to be able to decrease nominal interest rates in order to punish households and firms for &quot;holding cash&quot; and incentivize them to spend it instead. If you start with low (say, 2-3%) nominal interest rates during normal times, you don't have a lot of space to cut back nominal interest rates during the crises.</p>
<p>If, instead, you would have higher nominal interest rates (Krugman argued for around 8%) and relatedly higher inflation during normal times, you could easier cut back nominal interest rates during busts and stimulate the economy.</p>

CC BY-SA 3.0
2017-08-13T15:16:15.813Z
Regarding the downward rigidity of wages: in several countries is illegal to lower the wages, except if breaking the contract and creating a new one, which is highly disadvantageous for the employees (loss of seniority privileges for example)
JoaoBotelho
CC BY-SA 4.0
2020-10-30T03:52:25.323Z
@FooBar Interesting, since some inflation can help offset wage rigidity during a recession, could we say that "stagflation" is actually a good thing? I think typically, the phrase is loosely thrown about with a negative connotation.
Arash Howaida
CC BY-SA 4.0
2021-08-13T10:52:48.397Z
@ArashHowaida One assumes it would be better to get out of the recession. Lowering real wages can help perpetuate it, I think?
Criticize SE actions means ban
CC BY-SA 4.0
2015-05-29T16:25:22.657Z
2022-01-28T07:18:17.970Z
2022-01-28T07:18:17.970Z
FooBar
<p>Is zero inflation really desirable?</p>

<p>To be more precise: Does inflation in real life have benefits that in some situations outweigh its social cost? E.g.: it works as a disincentive against holding money. The treasury derives income from printing new bills, which usually inflates prices.</p>

CC BY-SA 3.0
2016-09-04T10:59:15.153Z
I wouldn't say that inflation is a tax on holding money. The government doesn't get any more money from inflation in the long run. Rather, inflation is a _disincentive_ on holding money.
ahorn
CC BY-SA 3.0
2016-09-04T18:03:03.780Z
@ahorn Indeed you are right. Seigniorage, which usually inflates prices somewhat is a form of tax, but inflation without is merely a disincentive.
Giskard
CC BY-SA 3.0
2016-09-04T19:39:10.043Z
@denesp I think seigniorage is insignificant. I think that the main purpose for the treasury to create money is to lower interest rates and stimulate spending. When there is high inflation, the treasury typically limits money supply in order to increase interest rates. Those two activities occur in conjunction.
ahorn
CC BY-SA 3.0
2016-09-04T20:35:11.497Z
@ahorn I don't think I wrote anything to the contrary.
Giskard
CC BY-SA 3.0
2015-05-31T00:08:49.500Z
Inflation is not a tax on wealth.  It is a tax on holding money.
Steven Landsburg
<macroeconomics><inflation><monetary-policy>
Is zero inflation desirable?
Giskard
# Is zero inflation desirable?

(Asked by: username_0 on 2015-05-29)

Is zero inflation really desirable?

To be more precise: Does inflation in real life have benefits that in some situations outweigh its social cost? E.g.: it works as a disincentive against holding money. The treasury derives income from printing new bills, which usually inflates prices.

**Tags:** macroeconomics, inflation, monetary-policy

> **Comments:**
> **username_2**: Inflation is not a tax on wealth.  It is a tax on holding money.  
> **username_1**: I wouldn't say that inflation is a tax on holding money. The government doesn't get any more money from inflation in the long run. Rather, inflation is a _disincentive_ on holding money.  
> **username_0**: @username_1 Indeed you are right. Seigniorage, which usually inflates prices somewhat is a form of tax, but inflation without is merely a disincentive.  
> **username_1**: @denesp I think seigniorage is insignificant. I think that the main purpose for the treasury to create money is to lower interest rates and stimulate spending. When there is high inflation, the treasury typically limits money supply in order to increase interest rates. Those two activities occur in conjunction.  
> **username_0**: @username_1 I don't think I wrote anything to the contrary.  

---

## 5 answers

### Answer by username_4 on 2015-05-29. Score: 36 | Accepted answer

The optimal level of inflation is very debated with unclear answers. There are many reasons, and a great answer would be very long. It should also distinguish between expected inflation and surprises.

I'm not going to do any of this, but giving you three reasons for a desirable positive level of inflation. This list is of course incomplete, also there are many reasons against too high inflation.

### Downward-rigidity of wages

It is really unclear to economists why it is happening, but nominal wages seem to be downward rigid. It appears to be a behavioral thing (and might not be true at all, see [Barro (1977)](https://ideas.repec.org/a/eee/moneco/v3y1977i3p305-316.html)), but it appears that in crises, once presented with the choice of more firings or reduction of wages, most firms/workers decide to not cut wages but rather respond to the slump with increased separations.

To the extent that we believe this lack of reduction in wages is suboptimal, the central bank can enforce a reduction in real wages through increased inflation rates, and thus preventing separations to some extent.

### Redistribution

This argument is based on Keynesian theory. Keynes claimed that the marginal propensity to consume out of income is smaller for rich households (and indeed, we do find this in the data to some extent). **Unexpected** inflation is similar to redistribution from creditors to borrowers, as long as debt contracts are not indexed to inflation.

To the extent that poor people consume more out of this unexpected wealth shock and than rich people decrease their consumption, this redistribution will lead to an increase in aggregate consumption.

### Room to cutback interest rates

This argument was most prominently brought forward by Krugman around 2008. In recessions, you want to be able to decrease nominal interest rates in order to punish households and firms for "holding cash" and incentivize them to spend it instead. If you start with low (say, 2-3%) nominal interest rates during normal times, you don't have a lot of space to cut back nominal interest rates during the crises.

If, instead, you would have higher nominal interest rates (Krugman argued for around 8%) and relatedly higher inflation during normal times, you could easier cut back nominal interest rates during busts and stimulate the economy.

> **Comments:**
> **username_9**: Regarding the downward rigidity of wages: in several countries is illegal to lower the wages, except if breaking the contract and creating a new one, which is highly disadvantageous for the employees (loss of seniority privileges for example)  
> **username_10**: @username_4 Interesting, since some inflation can help offset wage rigidity during a recession, could we say that "stagflation" is actually a good thing? I think typically, the phrase is loosely thrown about with a negative connotation.  
> **username_11**: @ArashHowaida One assumes it would be better to get out of the recession. Lowering real wages can help perpetuate it, I think?  

---

### Answer by username_2 on 2015-05-31. Score: 16

Money is produced at zero social cost but held at a positive private cost (because to hold money you must forgo holding other assets). Therefore there is a positive externality from holding money, which means that the usual arguments for subsidizing it apply. This makes the optimal rate of inflation negative (because inflation is a tax on holding money). In fact if you add a few details to the above argument, it's easy to see that the optimal rate of inflation is minus the real rate of interest.

On the other hand, funding the government is likely to require departing from an optimal tax system in which everything is taxed (or subsidized) according to the externalities it creates. Presumably the optimal departure entails higher taxes on most things, including money holding, which means that the optimal inflation rate should be somewhere north of $-r$. Whether it's north of zero is less clear.

> **Comments:**
> **username_4**: Perhaps it is late, perhaps I'm slow. What exactly is the positive externality?  
> **username_2**: @username_4:  There are two ways to see it.  First, there has to be an externality because the private and social costs are not equal.  The other way to see it is this:  Every time you choose to hold another dollar (instead of spending it), the price level falls, which increases the value of everyone else's money.  
> **username_2**: I'm a little mystified by the downvote....  
> **username_3**: https://en.wikipedia.org/wiki/Friedman_rule  
> **username_2**: @KennyLJ:  First, Coase certainly did not refute the usual arguments for taxing/subsidizing when there are externalities.  What he did was forcibly drive home the point that these arguments are sometimes outweighed by counter-arguments.  But the usual arguments certainly still apply.  (By analogy:  A good reason for me to buy a car is that it will shorten my morning commute.  A good reason not to is that I'll have to pay for a garage space.  The second reason might outweigh the first, but it does not invalidate it.)  
> **username_2**: @KennyLJ:  Second, once you've decided to subsidize money, the obvious way to do it is via deflation (so that money gains in value as you hold it).  What alternative do you envision?  

---

### Answer by username_7 on 2016-01-07. Score: 11

In the ECB's press conference of October 22, Draghi and his vice-president responded to the question of why the ECB is fighting low inflation so fiercely. Their answer provides a nice overview of why a low level of inflation is desired, and therefore should answer your question.

The following were their main arguments:

* low deflation is to be avoided because it increases the real value of debt and leads to costly debt servicing;
* measurement of inflation tends to be exaggerated by most price indices, therefore, targetting zero-inflation would imply deflation. This justifies why the inflation target should be above zero;
* with low or negative inflation, real interest rates may be too high to reach full employment;
* generally, central banks want to avoid deflation. The vice-president refers at this point to "real deflation" in contrast to "having negative inflation for a few months". This situation of "real deflation" should certainly be avoided, first, because of nominal rigidity in wages, and second, because it will lead to postponing consumption.

The transcript of the press conference can be found here: <https://www.ecb.europa.eu/press/pressconf/2015/html/is151022.en.html>


---

### Answer by username_5 on 2017-08-29. Score: 7

1. A little inflation is better than zero inflation (or deflation),
   because **wages are "sticky"** - they don't usually get adjusted
   downward.

   If a company is facing a year that is a bit worse than the previous
   year due to small fluctuations in demand, wages should actually be
   decreased. Companies typically don't cut wages though, so they might
   even choose to let go of some of their staff. Now, if there is 2%
   inflation and wages remain flat in nominal terms (nobody is getting
   a raise), wages will be down 2% in real terms. So the company is
   better able to cope with the slump in demand (its real costs are
   lower) and it might not have to let staff go.
2. Moderate inflation also makes it possible to have **negative real
   interest rates**. This gives central banks more flexibility to
   stimulate the economy.

   Real interest rate = Nominal interest rate - Inflation

   If inflation is zero and the nominal interest rate is zero, the real
   interest rate will be zero and the central bank won't be able to
   make interest rates go any lower (assuming nominal interest rates
   can't be negative). However, if inflation is say 2%, if the central
   bank sets the nominal interest rate to zero, the real interest rate
   will be -2%, giving a significant stimulus to the economy.
3. In general, moderate inflation also **helps keep the economy going**. If
   there is inflation and consumers or companies sit on cash, their
   holdings are being devalued in real terms. This gives them an
   incentive to spend and invest instead of hoarding cash.

> **Comments:**
> **username_6**: "Real interest rate = Nominal interest rate - Inflation" This is a close approximation for small values, but the real formula is real interest rate = (1+nominal interest rate)/(1+inflation). For instance, if the nominal interest rate is 50%, and inflation is 100%, then after one year you will have nominal dollars equal to 150% of your starting dollars, which will be worth 75% of your starting dollars.  

---

### Answer by username_8 on 2017-05-18. Score: 1

Related to your question, most of the CBs target an inflation rate near 2%.
Laurence Ball argues in his paper that targeting 4% could be better and his arguments are solid in my opinion.
<https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2468019>

It became in a sense a reserve engineering for your answer but I think the paper will be beneficial to show the relationship between inflation and policymaker's tools and to see undesirability of zero inflation.

> **Comments:**
> **username_9**: "Most central banks" - you mean the Eurozone and the US. This target was mainly pushed by Germany into the rules of the Eurozone. Germany has been for many years inflation averse, since their hyperinflation crisis in the 1930's.  

---

