Effects of inflation
Most effects of inflation are negative, and can hurt individuals and companies alike, below is a list of negative and "positive" effects of inflation:
(a) Positive Effects:-
- Encourages Hard work:-Mild inflation encourages hard work and effort among the citizens in order to meet the high cost of living. Individuals are encouraged to work hard in order to maintain their current living standards.
- It stimulates investments and profits:-Mild inflation increases the producers' profits which boost the level of investments in the economy. Tobin effect argues that a moderate level of inflation can increase investment in an economy leading to faster growth or at least higher steady state level of income. This is due to the fact that inflation lowers the return on monetary assets relative. to real assets, such as physical capital. To avoid inflation, investors would switch from holding their assets as money to investing in real capital projects.
- Government revenue increases:-It increases the revenue through increased taxation on expanding tax base.
- GDP growth:-It stimulates economic activities leading to expansion of GDP.
- Increased innovations:-Workers come up with innovations to improve on their earnings.
- Import substitution industrialisation:-Because of the need to avoid imported inflation, the establishment of import substitution industries leads to' self-reliance of the economy.
- Increased labour mobility:-Labour becomes more mobile both geographically and occupationally in order to earn a living.
- Forced savings:-Because during times of inflation, people receive incomes which cannot buy any reasonable quantity of goods, they are therefore forced to make savings; through the accumulation of small incomes which cannot buy anything substantial at once.
- Increased resource exploitation:-Due to effects of inflation the hitherto, idle resources are exploited as people struggle to earn a living.
- 'Entrepreneurship skills:- It promotes the development of entrepreneurship skills as people learn to do things that can enable them earn a living in hard times.
- Commercialization of the economy:- The use of money becomes widespread which eventually diminishes the subsistence sector.
- Employment opportunities:- Some jobs are created by entrepreneurs who invest in order-to take advantage of rising profitability in the economy,
- Benefits borrowers:- It might relatively benefit borrowers who will have' to pay the same amount of money they' borrowed (+ fixed interests), but the inflation could be higher than the interests, therefore they will be paying less money back.
- Helps lift the economy out of recession- Many economists favour a low steady rate of inflation, low (as opposed to zero or negative) inflation may reduce the severity of economic recessions by enabling the labour market to adjust more quickly in a downturn, and reducing the risk that a liquidity trap prevents monetary policy from stabilizing the economy.
- Benefits the inflators (those responsible for the inflation): It benefits early and first recipients of the inflated money because the negative effects of inflation are not there yet.
(b) Negative Effects:
- Lowers national savings: when there is a high inflation, saving money would mean watching your cash decrease in value day after day, so people tend to . spend the cash on something else.
- Loss of confidence in money: People begin to reject money as a medium of exchange in preference to barter transactions.
- Government unpopularity: People generally do not like inflation and it generates a source of grievances among many of the sufferers. The tension and industrial unrest created may discredit the government:
- Increased importation:-It encourages importation of cheaper goods from abroad.
- BOP problems:-The rising prices at home lead to a fall in exports but increase in imports. Exports become too expensive for the foreigners to buy yet imports become cheaper.
- Increases immorality:-It causes immorality in the society as people strive for a living e.g. smuggling, prostitution, gambling, speculation etc.
- Increased crime rates:-Crime rate increases as 'people 'struggle to earn a living through dubious means e.g. corruptions, theft, robberies, embezzlement etc.
- Increased strain:- It causes strain among people through long hours, of work in order to earn a living.
- Unfair income distribution:- During times of inflation, some groups become better off while others worsen-off. The stronger group gains while the weaker one loses. This causes misery among the majority who cannot afford high prices of goods and services.
- Huge losses due to Illusions of making profits:¬companies will think they were making profits while in reality they are losing money if they don't take into consideration the inflation rate when calculating profits.
- Unemployment problem. Some workers quit wage employment in urban areas because they cannot afford high cost of living.
- High interest rates:- Interest rates rise because lenders expect high rewards for lending their money. This discourages borrowing for investments yet the savings will also not rise due to money losing value.
- Fall in real incomes:-Fixed income recipients will be hurt because while inflation increases, their income doesn't increase, 'and' therefore their income will have less value over time.
- Loss of creditors:-Existing creditors will be hurt because the value of the money they will receive from their borrowers later will be lower than the money they gave before.
- Distortion of plans:-Government and individual plans cannot be implemented which consequently retard, economic growth, and development.
- Increased hoarding of money:-The amount of money held for speculation purposes increases.
- Failure of economic targets: Inflation makes it difficult to attain goals or other targets of economic policy.
- Reduced investment: many companies will have to go out of business because of the losses they incurred from inflation and its effects.
- Encourages hoarding:- people will try to get rid of cash- before if is devalued, by hoarding food and other commodities creating shortages of the hoarded objects.
- Distortion of relative prices:- usually the prices of goods go higher, especially the prices of commodities.
- Higher uncertainties: uncertainties in business always exist, but with inflation risks are very high, because of the instability of prices.
- Causes an increase in tax bracket- people will be taxed a higher percentage if their income increases following an inflation increase.