ns the atmosphere for promotion of savings and allocation of investment. Moreover, there is a social element: inflation adversely affects those who have no protection against inflation; i.e., the poorer sections of the community. The critical question for policy makers is, thus, at what level of inflation do its adverse consequences begin to set in? Inflation affects fiscal balance in several ways. “It adversely affects fiscal deficit when elasticity of expenditure to inflation is higher than that of revenue. A more significant impact of inflation arises from its effect on interest rate and the dynamic sustainability of fiscal situation. High rates of inflation signal weak resolve to control inflation and imply higher expected inflation in future.” Obviously, this results in upward rigidity in nominal interest and leads to high debt service burden on the budget, thus reducing the flexibility of fiscal management. And as just noted, it is well known that the adverse implications of inflation are more intense at high rates of inflation. A moderate inflation rate is usually more desirable, and manageable as it ordinarily does not imply severe costs. Indeed, moderate inflation rates are necessary if money is to remain a useful unit of account and if the costs of decision making are to be minimised. But, there is no consensus as to the optimum rate of moderate inflation, or even as to what the term ‘moderate’ means. “International evidence suggests that the costs of uncertainty tend to rise in a non-linear fashion with the inflation rate exceeding a threshold. One important caveat in interpreting the threshold of inflation rate beyond which costs exceed benefit is the provision of inflation protection measures available in the economy, which tends to moderate the adverse implications to some extent.” In other words, countries with a moderate inflation rate, but an inadequate indexation provisio...
