Describe how inflation can be costly even if it is anticipated. ...

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Describe how inflation can be costly even if it is anticipated.
 
  What will be an ideal response?

Question 2

If rational workers and firms know that the Federal Reserve is following a contractionary monetary policy, they will expect inflation to ________ and will adjust wages so that the real wage ________.
 
  A) increase; decreases B) decrease; increases
  C) increase; remains unchanged D) decrease; remains unchanged

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Answer to Question 1

First, there will be redistribution as some incomes fall behind even an anticipated level of inflation. Second, firms and individuals must hold money to perform transactions. Those holding money lose purchasing power at a rate equal to inflation. Third, firms must pay individuals to change prices. These costs, called menu costs, can be substantial at very high levels of inflation. Fourth, investors have to pay higher taxes on interest and capital gains income as the government taxes nominal interest and capital gains income. Investors then lose real after-tax income.

Answer to Question 2

D