Low inflation has many benefits:
- If inflation is stable and low businesses will be more confident to invest, leading to an increase in aggregate supply and enable higher degrees of economic growth in the future.
- Low inflation rate maintains the real income or the purchasing power of labours moderately stable, resulting in the cost of production to remain stable.
- Low inflation rate helps in attaining a more efficient allocation of resources. When the price level of services and goods rise, the relative profitability of services and goods shifts and the producers will allocate more resources in the production of more profitable services and goods.
High inflation has other costs such as ‘Menu costs’, which is the cost of changing price levels if the inflation is higher in the domestic country because less competitive resulting to a decline in exports, and deterioration in the current account of the balance of payments.
Inflation mostly conflicts with unemployment. Hence to keep the inflation rate low, the government can employ a contractionary fiscal policy. This decreases aggregate demand will make the producers decline output resulting in unemployment to boost.