New Study from Central University of Finance and Economics Examines How Economic Policy Shapes the Effects of Inflation

BEIJING, March 16, 2023 /PRNewswire/ -- The long-term effects of inflation on the economy are widely discussed and extensively debated. Now, researchers in China suggest that inflation in an unregulated market increases wealth at the top of the social hierarchy and prevalent economic policies determine inflation's effects on output and social welfare.

Inflation has wide-ranging effects on the economy. While high levels of inflation are generally bad for economic growth, inflation at manageable levels can sometimes have beneficial effects, especially in the long-term. Moreover, inflation may not affect people of all economic classes in the same manner. Therefore, to answer the question, "is inflation good or bad?" it is necessary to look at the specific measure of economic prosperity and its effects on the poor and the rich separately.

In a recent study made available online on 22 February 2022 and published in volume 201 of the Journal of Economic Theory on April 1, 2022,  Associate Professor Gu Jin of Central University of Finance and Economics (CUFE), China, and his colleague investigated the real effects of long-term inflation on economic output, wealth distribution, and welfare using a "decentralized" model, wherein individuals trade their labor income with a partner in one-on-one bouts in an unregulated market.

Their findings indicate that under long-term inflation, both regressive (poor to rich) and progressive (rich to poor) wealth transfers in an unregulated system serve to increase economic disparity such that more wealth becomes concentrated at the top. Another key finding of their study is that the economic policy underlying wealth transfer can greatly influence the effect of inflation on output and welfare. In a scenario where trading happens in an unregulated (decentralized) setting, inflation increases economic output and decreases social welfare by transferring money from the poor to the rich. However, in a setting where trades are regulated by an intermediary, such as a central bank or the government (centralized setting), inflation reduces output and increases social welfare.

"It is widely acknowledged that inflation in the long run affects the economy. What this piece of research adds is the knowledge that the effects not only depend on the type of underlying inflationary policy, i.e., how it redistributes wealth, but also crucially on the market structure of the economy, i.e., whether the markets are more centralized or decentralized," explains Dr. Jin.

The findings show that risk is the main factor influencing individual trading decisions. Under long-term inflation in a decentralized system, individual risk is low, but the potential to increase economic output is high. Under inflation in a centralized system, individual risk is low, but so is the output-increase potential. Moreover, in such a system, it becomes possible for regulators to increase both economic output and welfare at the same time.

How may these findings help us? Dr. Jin explains, "With a better understanding of inflation, policy-makers can hopefully be more cautious and confident when dealing with inflations, and people may find their lives, job opportunities, and the economy at large less disrupted by inflations."

Reference

Title of original paper: Heterogeneity, decentralized trade, and the long-run real effects of inflation

Journal: Journal of Economic Theory

DOI: https://doi.org/10.1016/j.jet.2022.105439

Media contact:
Dr. Ling Huang
[email protected]
0086-10-62288468

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SOURCE Central University of Finance and Economics, China