inflation rate discourages people from entering into any form of long -term contract.
This is an additional cost of high inflation, because high rates of inflation are usually
unpredictable, too. In countries with high and uncertain inflation, long - term loans are
rare. This, in turn, makes it difficult for people to commit to long -term investments.
One last point: unexpected deflation—a surprise fall in the price level—creates win-
ners and losers, too. Between 1929 and 1933, as the U.S. economy plunged into the
Great Depression, the price level fell by 35%. This meant that debtors, including many
farmers and homeowners, saw a sharp rise in the real value of their debts, which led to
widespread bankruptcy and helped create a banking crisis, as lenders found their cus-
tomers unable to pay back their loans.
Inflation Is Easy; Disinflation Is Hard
There is not much evidence that a rise in the inflation rate from, say, 2% to 5% would do a
great deal of harm to the economy. Still, policy makers generally move forcefully to bring
inflation back down when it creeps above 2% or 3%. Why? Because experience shows that
bringing the inflation rate down—a process called disinflation—is very difficult and
costly once a higher rate of inflation has become well established in the economy.
Figure 14.2 shows the inflation rate and the unemployment rate in the United
States over a crucial decade, from 1978 to 1988. The decade began with an alarming
rise in the inflation rate, but by the end of the period inflation averaged only about
4%. This was considered a major economic achievement—but it came at a high cost.
Much of the fall in inflation probably resulted from the very severe recession of
1981–1982, which drove the unemployment rate to 10.8%—its highest level since the
Great Depression.
Many economists believe that this period of high unemployment was necessary, be-
cause they believe that the only way to reduce inflation that has become deeply embed-
ded in the economy is through policies that temporarily depress the economy. The best
way to avoid having to put the economy through a wringer to reduce inflation, how-
ever, is to avoid having a serious inflation problem in the first place. So, policy makers
respond forcefully to signs that inflation may be accelerating as a form of preventive
medicine for the economy.
module 14 Inflation: An Overview 139
Section 3 Measurement of Economic Performancefigure 14.2
The Cost of Disinflation
The U.S. inflation rate peaked in
1980 and then fell sharply. Progress
against inflation was, however, ac-
companied by a temporary but very
large increase in the unemployment
rate, demonstrating the high cost
of disinflation.
Source:Bureau of Labor Statistics.Inflation
rateUnemployment
rateYear197841980 1982 1984 1986 198861216%14681012%2108Unemployment rateInflation rateDisinflationis the process of bringing the
inflation rate down.