The Effects of Inflation

Text В

The Effects of Inflation

Inflation is regarded as undesirable because it produces some serious economic and social problems.

1.

Inflation leads to an arbitrary redistribution of real income. Although a rise in the general price level produces 2 corresponding rise in money incomes, all prices do not rise ю the same extent and different income groups will be

affected in different ways. There will be some 'gainers' and some 'losers'.

The losers are those whose incomes are fixed, or relatively fixed, in money terms. This group will include people whose income is derived from fixed interest securities, controlled rents, or some private pension schemes. Income recipients in this category will experience a fall in their real incomes.

When incomes are directly related to prices, real income will remain relatively unchanged. The incomes of sales people, and professional groups such as architects, surveyors, and estate agents whose fees are expressed as a percentage of the value of the work undertaken, fall into this category. A large number of wage earners also come into this group since many workers have agreements which link their money wages to the Retail Price Index.

The effects on incomes derived from profits depend largely upon the kind of inflation being experienced. During demand-pull inflation, profits tend to rise. The prices of final goods and services tend to be more flexible in an upwards direction than many factor prices, some of which are fixed on fairly long-term contracts. The margins between the two price levels tend to widen because of this time lag. When there is cost-push inflation, profits may he squeezed. Since there is no excess demand some firms may find it rather difficult to pass on the full effects of rising cost in the form of higher prices.

Wage earners generally more than hold their own when the price level is rising. In the UK and most other industrial countries wages in most years have risen faster than prices, but as already mentioned, there tends to be some redistribution effect as those with superior bargaining power gain at the expense of the weaker groups.

Inflation tends to encourage borrowing and discourage lending because debtors 'gain' and creditors 'lose'. Debtors repay in monetary units which have less purchasing power 

Rohan those which they borrowed. If a person borrows a sum money for 2 years during which time inflation is running - 10 percent per annum, the same sum repayable at the end : the term will be worth about 17 percent less in real purchasing power than the sum of money borrowed. It is for this reason that lenders demand higher rates of interest during periods of inflation.

2.

Demand-pull inflation is associated with buoyant trading conditions and sellers' markets where the risks of trading ire greatly reduced. These easy market conditions might give rise to complacency and inefficiency since the competitive pressures to improve both product and performance «ill be greatly weakened. This is not likely to be the case in 2 cost-push inflation where trading conditions are likely to place a premium on greater efficien