Working paper No. 78
Hasan Bakhshi, Andrew G Haldane and Neal Hatch
This paper quantifies some of the costs of inflation in the United Kingdom. It focuses in particular on inflation distortions under an imperfectly indexed tax system and distortions to money demand. In the United States, an earlier study by Feldstein found that lowering inflation by 2 percentage points could generate welfare benefits of as much as 1% of GDP per year forever. In the United Kingdom, the benefits are found to be smaller, but still substantial, at 0.2% of GDP per year.
The technique used is based on quantifying the familiar welfare triangles under a demand curve. The welfare losses are significant because the interaction of taxes and inflation means that the welfare losses are trapezia rather than triangles. The paper also takes account of any welfare loss/gain associated with a change in government revenue. The paper goes on to perform sensitivity analysis on each of the key behavioural parameters, and to compare the welfare gains of lower inflation with the costs of disinflation.