The Effects of Inflation

So, we have established the causes of inflation. But what are the effects?

Loss of overseas competitiveness.

This means that if prices in the country are subject to inflation, the prices of goods from that country (including those sold abroad) become more expensive to buyers overseas in the global market. This leads to lowered exports due to the fact that the consumers will use another cheaper supplier from another country where perhaps inflation is lower.

Import penetration occurs too because people within the country start to import more of their products in that they are cheaper than domestic ones even despite the increased distance they have to be shipped.

Real income is transferred

Inflation causes real income to move between different groups of people:

• Non Unionised to Unionised workers

Those in Trade Unions will probably benefit from their Union's influence across the country in order to negotiate higher wages in response to inflation and the associated rise in the cost of living.

• Tax Payers to Governments

Fiscal drag occurs here because the Government sometimes see revenue as a time to make some extra tax revenue. They are slow to move up the tax brackets and so when there is an increase in wages to respond to inflation, they end up paying some income tax at a higher rate. Income Tax allowances are usually slower to be amended than the rising wage rates.

• Lenders to Debtors

It's great for those in debt. although technically they still have to pay back the same balance, each pound they pay back is no longer worth as much and so the lender loses out. 

• Unemployed to those in work

Those in work will demand a higher wage in order to maintain their standard of living if the cost of living has increased due to inflation. Therefore this causes further inflation in that firms increase prices to maintain their profit margins. This is necessary when extra labour costs do not convert into extra productivity. The process described here is known as the Wage Price Spiral. Hence for those on fixed incomes or those without pay rising prices is a major issue. If you aren't on a fixed income your income will increase in line with inflation so you don't feel the effects as much.

Effect on capital investment

Firms spend less on capital goods due to the increase in price. However others will decide that the time is right to buy in speculation that if they wait, inflation will make prices more expensive. Furthermore if they kept the capital as savings, then inflation would erode its value so when they come to spend it in the future, it would be valued as less even after taking into account the interest received.

Hence the Monetary Policy Committee increase interest rates to encourage saving. Also this attempts to trim demand if consumers are saving as opposed to spending and so demand pull inflation is limited.

However this high interest rate leads to a higher nominal interest rate which impacts growth because buyers lose confidence in the market and "shoe leather costs" increase - This being the an increased time for a consumer to shop around for the best deal on a particular product.

For those firms using menus or catalogues there may be costs associated with altering the prices of its products. Argos produces only a few new editions of its catalogue per year and so this will be a rather costly procedure.

ITS NOT ALL DOOM & GLOOM

Possible Benefits of Inflation:

Possible Business Growth

Falling debt values 

Higher Stock Values 

Rising asset values such as property

So, depending on the nature of your firm, or your livelihood inflation will affect you for the better or maybe for the worse.

Why not read:

Inflation introduction   ,   Causes of Inflation