What, If Any, Is The Link Between Inflation And Output In Your Essay

What, If Any, Is The Link Between Inflation And Output In Your Discussion Refer To Both Theoretical And Empirical Evidence - Essay Example When prices of domestic goods and services are rising fast this will generally be true also of wages, of the prices of the imported goods, of the money supply and of the prices of assets. This is because inflation is one sector of the economy permeates rapidly into other sectors. The phrase â€Å"a high rate of inflation† therefore usually describes a situation in which the money values of all goods in an economy are rising at a fast rate . The view commonly taken is that inflation should be kept close to zero; prices should rise at no more than about 2 to 3 percent a year on average. This is because high inflation affects the economy adversely in a number of ways. For example, it distorts the income distribution; because of the difficulty and risk associated with the complete index-linking of pensions tend to suffer. Also, it biases investment decisions: the cost of borrowing money rises making debt finance expensive in the early years of a project and reducing the incentive to invest. In theory inflation accounting could correct for this, but in practice this has proved difficult to implement.