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The Upside of US Inflation

In recent decades, inflation has been a boon to middle-class US households’ balance sheets, thus helping to mitigate the increase in overall wealth inequality. Those worrying about the recent uptick in inflation – beginning with the Federal Reserve – should bear this in mind when considering whether and how much to tamp it down.

NEW YORK – Anxiety about inflation, among citizens and politicians alike, has been peaking recently. In the United States, the year-on-year increase in consumer prices reached 7.5% in January, the highest rate since February 1982. If people’s incomes increase by less than the rate of inflation, their real incomes decline, and they cannot afford to buy as much stuff as before. This is the “income effect” of inflation.

But, as I show in a recent research paper, there is an upside to inflation. In recent decades, in fact, inflation has been a great boon to middle-class US households’ balance sheets, and has therefore helped to mitigate the increase in overall wealth inequality.

This is the “wealth effect” of inflation, and it works in the following way. Suppose you have $100 in assets and $20 in debt, so that your net worth is $80. Suppose, too, that inflation is 5% per year and the nominal value of your assets increases at the same rate (the prices of assets such as homes tend to move in line with inflation). Then, in real terms, the value of your assets remains unchanged, but your debt is now 5% lower. So, the real value of your net worth rises to $81, an increase of 1.25%.

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