With all the fiscal and monetary stimulus that has been poured into the economy, there is a lingering fear that inflation will rear its ugly head somewhere down the line. We’ve discussed how unanticipated inflation can take a bite out of both stock prices and free cash flow. But if inflation is allowed to creep higher, and is stabilized at a higher level, would that be a problem going forward for the broader economy? Assuming retirement benefit payments are linked to CPI, if our inflation target was 10% instead of 3%, would that be an issue? Common sense suggests nominal interest rates would adjust, and in the long-term this would have little effect on the country’s real GDP (i.e. after adjusting for inflation). However, digging a little deeper we do find extra costs associated with a higher inflation rate, even when that rate is expected and anticipated!
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