136 section 3 Measurement of Economic Performance
Israel’s Experience with Inflation
It’s hard to see the costs of inflation clearly be-
cause serious inflation is often associated with
other problems that disrupt the economy and
life in general, notably war or political instability
(or both). In the mid-1980s, however, Israel ex-
perienced a “clean” inflation: there was no war,
the government was stable, and there was
order in the streets. Yet a series of policy errors
led to very high inflation, with prices often rising
more than 10% a month.
As it happens, one of the authors spent a
month visiting Tel Aviv University at the height of
the inflation, so we can give a first - hand ac-
count of the effects.
First, the shoe - leather costs of inflation were
substantial. At the time, Israelis spent a lot of
time in lines at the bank, moving money in andout of accounts that provided high enough inter-
est rates to offset inflation. People walked
around with very little cash in their wallets; they
had to go to the bank whenever they needed to
make even a moderately large cash payment.Banks responded by opening a lot of branches,
a costly business expense.
Second, although menu costs weren’t that
visible to a visitor, what you could see were the
efforts businesses made to minimize them. For
example, restaurant menus often didn’t list
prices. Instead, they listed numbers that you
had to multiply by another number, written on a
chalkboard and changed every day, to figure out
the price of a dish.
Finally, it was hard to make decisions be-
cause prices changed so much and so often. It
was a common experience to walk out of a
store because prices were 25% higher than at
one’s usual shopping destination, only to dis-
cover that prices had just been increased 25%
there, too.fyi
The shoe-leather costs of inflation in Israel:
when the inflation rate hit 500% in 1985, peo-
ple spent a lot of time in line at banks.Ricki Rosen/Corbis Sabalevel of prices in the United States was much higher than it was in 1969—but that, as
we’ve learned, didn’t matter. The inflation rate in the 2000s, however, was much lower
than in the 1970s—and that almost certainly made the economy richer than it would
have been if high inflation had continued.
Economists believe that high rates of inflation impose significant economic costs.
The most important of these costs are shoe -leather costs, menu costs,andunit -of -account
costs.We’ll discuss each in turn.
Shoe - Leather Costs People hold money—cash in their wallets and bank deposits on
which they can write checks—for convenience in making transactions. A high inflation
rate, however, discourages people from holding money, because the purchasing power
of the cash in your wallet and the funds in your bank account steadily erodes as the
overall level of prices rises. This leads people to search for ways to reduce the amount of
money they hold, often at considerable economic cost.
During the most famous of all inflations, the German
hyperinflationof 1921–1923, merchants employed runners
to take their cash to the bank many times a day to convert
it into something that would hold its value, such as a sta-
ble foreign currency. In an effort to avoid having the pur-
chasing power of their money eroded, people used up valuable
resources—the time and labor of the runners—that could have
been used productively elsewhere. During the German hy-
perinflation, so many banking transactions were taking
place that the number of employees at German banks
nearly quadrupled—from around 100,000 in 1913 to
375,000 in 1923. More recently, Brazil experienced hyper-
inflation during the early 1990s; during that episode, the
Brazilian banking sector grew so large that it accounted for 15% of GDP, more than
twice the size of the financial sector in the United States measured as a share of GDP.
The large increase in the Brazilian banking sector that was needed to cope with the
consequences of inflation represented a loss of real resources to its society.Compassionate Eye Foundation/Siri Stafford/DigitalVision/Getty Images