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September 05, 2008

What's the optimal inflation rate?

With relatively high inflation cited as an important issue by most people, the question then becomes, What is the best inflation rate? Many would say zero or negative, meaning prices are falling. What do economists say? Listen

Dr. Mike Walden, North Carolina Cooperative Extension economist in the College of Agriculture and Life Sciences at N.C. State University, responds:

"Well, this has been a question that's been bandied back and forth by economists for several decades, and the conclusion right now - if you can say that economists agree on anything - is that probably an inflation rate between 1 and 2 percent is optimal. And there are several reasons for that. First of all, measured inflation tends to be on the high side, and we won't go into why, but we tend to overstate inflation, so if you have a 1 to 2 percent measured rate, your actual rate may be closer to zero. Secondly, there are a couple of issues if you have a negative inflation rate. One, is that ultimately that would cause workers wages to fall, and of course, we don't like that. It would also increase the real value of your debt. In other words, if your debt payments are set in a specific dollar amount and prices are going down, the actual burden of that debt is higher. And finally, low inflation rates imply low interest rates, and in terms of public policy for the Federal Reserve that gives them less wiggle room to reduce interest rates when the economy is in a downturn or recession."

Posted by Dave at September 5, 2008 08:00 AM