ECONOMICS (MACRO ECONOMICS)
EFFECTS OF INFLATION INTRODUCTION
Inflation
is usually defined as the persistent increase in the general price level in this case will be average of the prices of domestic and foreign goods. In practice,
inflation is normally
measured by the change in the consumer price index (EPI), the average price of the basket of goods and services consumed by a representative household.
EFFECTS Inflation redistributes incomes as the fixed income earners (for example Civil Servants, Creditors, Pensioners etc.) loose and others such as business men and debtors gains. People on contract jobs without cost of living adjustments stand to loose in case the inflation rate is above what is expected.
Higher rates of inflation may distabilise the economy by inhibiting growth through discouraging of swamps and hence investments. This will thus have longrun effects of growth.
Inflation worsens the balance of payments (BOP) problem. It makes domestic products expensive in international markets hence rendering them less competitive and many countries would not be willing to buy from a country hit by inflation. On the other hand, imports continue flowing into the country and as a result this worsens the BOP problem. This applies best in LDC’s (Less Developed Countries) whose BOP position because of controlled capital accounts.
The functioning efficiency of the price mechanism is reduced because the functioning of money as a store of wealth unit of account and as a measure of value is undermined, people therefore rush to spend their money as they get it because of the fear to loose value.
Inflation may cause social and political disorders because it reduces people’s standard of living (SOL) and their purchasing power.
Another effect of inflation is what normally called the “men costs”. This is general term that describes the inconvenience of having to adjust certain prices to keep them in line with inflation. Real costs are therefore incurred in changing over vending machines, public phones etc. when the nominal price level changes (Sachs 1993).
Inflation may also lead to resource misallocation through the effects of inflation on the tax system. Suppose the marginal tax brackets are stated in nominal terms, as time goes by and nominal income rises, people are pushed into higher tax brackets, increasing their marginal task rates. Fixed income earners therefore suffer increased tax liabilities.
Inflation is a tax:- It is a tax on the peoples incomes. It mainly refer to capital loses suffered by money holders as a result of inflation. It should however be noted that the amount of resources transferred by the inflation tax is a function of rate of inflation and of the elasticity of demand for real cash balances.
In summary, the above discussion has given us a green light on the effects of inflation in an economy, and also defined the meaning of the word inflation. It clearly shows us how inflation is measured. It is measured by a change in the consumer price index (CPI).
Written By: A. B. Kintu B. Comm (Hons) Marketing Makerere University (2007).