One of the recurring themes you see in debates over monetary policy is the idea that inflation is a moral issue. People will often point out indignantly that today’s dollar is worth only five percent of what dollars were worth a century ago. Inflation hawks sometimes describe inflation as a kind of theft.
Clearly, really high levels of inflation have devastating economic consequences, as Weimar Germany and modern‐day Zimbabwe have discovered. But so long as inflation is kept at the moderate, largely single‐digit levels Western democracies have seen in recent decades, moralizing about inflation simply doesn’t make sense. There’s no particular reason to prefer an inflation rate of 0 to a 2 percent or 4 percent inflation rate, and indeed, the latter may have important advantages.
Economists like to say that money serves two primary purposes: it serves as a medium of exchange and a store of value (many also describe it as a unit of account, but this is largely a consequence of the other two functions). Inflation—even in the single digits—prevents money from working effectively as a long‐term store of value. If you were born in 1920 and your retirement plan was to put $100 bills under your mattress, the inflation of the 1970s would have destroyed the majority of the value of your savings.
The problem with this line of argument is that even stable money is a bad long‐term store of value. That’s because modern capital markets offer you the opportunity to not just preserve the value of your money but dramatically increase it by investing in productive assets. You can buy stocks, bonds, or real estate, all of which generate a stream of income that increases the value of your investment.
Stocks and real estate are inherently inflation‐protected; if the price level doubles, the value of your house and your shares of Microsoft stock will double with it. And bonds typically pay an interest rate that “prices in” the expected rate of inflation over the course of the bond’s life. So an economy with a consistent inflation rate of 5 percent isn’t particularly better or worse for savers than an economy with a stable price level.
Of course, unexpected changes in the price level can cause losses (or gains) for savers. But given how easy it is to invest in inflation‐protected assets, it’s hard to see why this should be regarded as an injustice perpetrated against people who hold dollars. If I invest my life savings in oil, and then Saudi Arabia discovers a massive new oil well that causes the price of oil to drop by 10 percent, it would be silly to say that Saudi Arabia has stolen 10 percent of my life savings. I just made a bad bet. Exactly the same point applies to money.
So there’s an important assymetry between the “medium of exchange” function of money and its “store of value” function. There are many alternative assets that can perform money’s “store of value” function;some of them perform the role even better than dollars do. But only dollars play the “medium of exchange” role in the United States. That’s why if there aren’t enough dollars to go around, people start cutting back on their spending and the economy goes into recession. So it’s foolish for a central bank to become so concerned with preserving the long‐term value of the dollar that it fails to provide enough liquidity, thereby tipping the economy into a recession. Ensuring that money performs its “medium of exchange” function well should be a central banker’s top priority, even if that means allowing the currency to lose value over time.