Effects of Inflation

Effects of InflationEffects of Inflation

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

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

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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.

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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.

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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.

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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.

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

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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

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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.

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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.

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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).

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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).

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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.

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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

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

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

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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.

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

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

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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.

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Date post:	18-Mar-2016
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Effects of Inflation

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