Effects of Inflation

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Effects of InflationEffects of Inflation

Md. Nuruzzaman, Ph.D.Director (Training), NAPD

Impact on Output - In general inflation has major costs for the economy, the producer and the consumer.

Inflation causes productive investment to fall because profitability falls, speculative investment rises which has a negative effect on employment, output and income. Inflation causes resources to be misallocated.

Inflation causes uncertainty to increase which can erode business and consumer confidence.

The drop in confidence can reduce investment and consumption which produce downward pressure on employment and production.

Inflation leads to domestic interest rates increasing. Like other prices, the price of money rises to compensate suppliers of money (lenders/savers) for the falling value of the dollars they are repaid. This reduces investment and consumption leading to negative effects on employment and output.

If inflation rate is greater than overseas inflation rates, exports decrease and imports increase. This reduces output and employment. Inflation makes a country less internationally competitive, the Current Account deficit also rises.

Government may tighten fiscal and monetary policies to reduce inflation, thus causing unemployment to rise and production to decrease.

Effects of InflationEffects of Inflation Inflation causes a redistribution and

reallocation of resources to the following groups: Speculators Borrowers/Lenders Strong Employee Groups in Key Industry Monopolies / Oligopolies in Key Industries Government

Speculators: buy and sell property, collectables (eg: art precious metals) etc. during inflationary periods because these items rise faster in price than the general price level which results in Speculator’s real income increasing.

Borrowers/Lenders - (depending on interest rates): borrowers benefit if the inflation rate is greater than the interest rates. They pay back dollars of less value and lenders lose.

Strong Employee Groups in Key Industries: can use industrial ‘muscle’ to gain wage/fee increases greater than other groups of employees and the inflation rate ( distributive affect).

Monopolies / Oligopolies in Key Industries: can raise their prices ahead of inflation and / or pass on cost increases to consumers to maintain or raise profits (distributive effects).

Effects of InflationEffects of InflationGovernment: revenue rises due to bracket

creep, ie: inflation lifts people into higher income and marginal tax brackets, where they pay a higher proportion of income tax to the government.

Effects of InflationEffects of Inflation Inflation causes a redistribution and reallocation

of resources away from the following groups: Fixed Income Earners Weak Union or Non-union Sections

of the Workforce Borrowers/Lenders Firms in Highly Competitive or

Depressed Industries Savers

Fixed Income Earners: real incomes decrease as changes to money incomes lag well behind inflation e.g: the unemployed, public servants etc.

Weak Unions or Non-unionised Sections of the Workforce: their money incomes fall behind inflation because they lack industrial ‘muscle’.

Borrowers/Lenders (depending on interest rates): borrowers lose if interest rates move ahead of inflation. Lenders anticipate inflation and raise rates to protect real returns.

Firms in Highly Competitive or Depressed Industries: rising costs reduce profits when firms cannot easily raise prices.

Savers: savings in conventional low interest bank deposits lose value.

Conclusion: Inflation transfers income between competing income groups. It causes a redistribution of income away from weaker, low income earners to more protected high earners in both private and public sectors.

Effects of Inflation

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