EFFECTS / PROBLEMS OF INFLATION

- EFFECTS / PROBLEMS OF INFLATION

Inflation can cause difficulties for ordinary people, organizations and the country as a whole. Some of the reasons are :

1. It tends to accelerate

When inflation occurs for sometime, people begin to anticipate future price increases. Workers start demanding higher wages on past and expected future price increase. If the employers give them the wage rises, it will push up the cost of production, push up the prices, and further raises inflation. This is called Wage Price Spiral.The firms also start raising the prices to cover both past and expected future increases in costs. All these give rise to cost push inflation and tend to speed up the rate of inflation.

2. It effects the distribution of income

When inflation takes place, people try to increase their incomes, and some may be more successful than others. Some trade unions are in strong bargaining position, and are able to protect the real wages of some workers, others may not be able to do it and real wage  of these workers fall.

Some group of people who are dependent on private pensions or obtain income from fixed income securities, will not be able to avoid a fall in the real income. All these will increase the gap between the real incomes of people and effect the overall distribution of income.

3. Borrowers (Debtors) gain at the expense of Lenders (Creditors)

Borrowers gain during inflation because the real worth of money which they pay as interest declines as a result of inflation. Lenders lose because the real worth of interest which they get is less than what they had hoped before inflation started.As the largest borrower, the Government benefits from inflation. It is able to repay its debts with money which has a lower value than the money borrowed.

4. It affects the balance of payments (increase imports and decrease exports)

A country may get into difficulty if its inflation rate is more than its competitors. If the prices of goods produced in UK are rising faster than prices of other competing countries, then it will be cheaper to import the goods and exports will become difficult (costlier). This will affect the balance of payment position and it moves into deficit.

     5.

·         People who get a fixed annual money income from property or money lent by them, lose during inflation. For example” The rent received by them being fixed for a certain period of time, they cannot be varied easily.

·         Creditors lose where as the debtors are gainers during a period of inflation. Borrowers gain as the real value of the money which they pay back is much less than when they borrowed. Creditors lose during inflation since they receive less in real terms.

·         Securities carry a fixed rate of interest fro a specified period. So during periods of rising prices, holders of securities lose.

·         Inflation also effects the course of international trade of a country. In view of rising prices in the domestic economy, exports tend to decline and imports tend to increase. As a result there will be unfavourable balance of payments.If unfavourable balance of payments persists for quite some time, the external value of the currency will tend to decline.