Some benefits of reducing inflation in South Africa

Abstract

This paper evaluates the welfare gain from reducing inflation permanently from two percent to price stability and compares the output cost associate with this transition. The paper emphasizes the distortions caused by the interaction of inflation and capital income taxation, in calculating the gain from moving to a zero rate of inflation. Though the annual deadweight loss of a two percent inflation rate is 0.20 percent of GDP - a relatively small number when compared to the literature, since the real gain from shifting to price stability grows in perpetuity at the rate of growth of GDP, the present value is a substantial multiple of the annual welfare gain. Calculations reveal a present value gain of 13.33 percent of GDP. Since the corresponding one-off output cost of moving from two percent inflation to price stability is 0.034 percent of GDP, the gain outweighs the cost by an overwhelming margin.