High Inflation dampens the ability of governments to achieve their ultimate objective of enhancing their citizens’ wellbeing. It widens income inequalities between the rich and the poor, reduces the price competitiveness of goods and services leading to balance of payment problems, discourages savings and lending, causes economic and political instability etc. The true consequences of inflation however, depend on its rate, how old it is, whether it is anticipated or unanticipated and the inflation rates of other countries.
A rapid rate of inflation implies a sharp rise in the cost of living. Consequently relatively poor individuals or those belonging to low income classes suffer more than the rich. Fixed income earners, pension bearers and those deriving income from fixed interest securities etc. lose when price level rises. This is because they have lesser to spend in real terms or their purchasing power is eroded due to higher prices of goods and services. Businessmen on the other hand, can shift the burden of increased costs to consumers, particularly if the demand for their products is price inelastic.
A country facing a comparatively high inflation rate experiences reduced price competitiveness of goods and services both at home and abroad. Exporters lose whereas importers’ businesses flourish from consumers wanting to spend more on decreased exports lead to a rising trade deficit, putting pressure on the economy inflation becomes a major problem for an economy if it results in a persistent trade deficit and drains national official reserves. Higher inflation creates uncertainty and distortion which saps the underlying strength of the economy and causes steeper, more volatile business cycles.
Costing and pricing decisions become even more difficult, forcing investors to either avoid or delay their investment and expansion plans. Long term contracts are discouraged and frequent changes in prices damage relationships between byers and suppliers. Some investors prefer non-productive business activities such as keeping finished good in stocks (hoarding), anticipating higher prices. Investment decisions may also be influenced by the impacts of inflation on lending, borrowing and saving decisions.
Real interest rates decrease when price level rises and may even be negative if inflation rate exceeds nominal interest rates. Lending and savings are discouraged when inflation rate increases since real interest rate falls. Borrowers gain at the expense of lenders as they pay back less in real terms during periods of inflation. There are other minor, menu and shoe leather costs associated with inflation. Higher price level forces firms to spend huge sums of money on printing new menus and informing distributors and customers about these price changes.
Consumers spend more time in searching for a better deal and negotiating prices when high inflation rate reduces their purchasing power. This increased search time reduces the pace of economic activity and results in wastage of time and energy. Inflation may appear necessarily harmful at first glance. However, a low steady and anticipated rate of inflation may actually be beneficial for the economy. Creeping inflation as it is known, can usually be anticipated and signals growth and prosperity within the economy. It generally allows firms to experience increased profitability, making available greater funds for investment.
Cosing and pricing decisions become easier and firms spend less money on printing new menus and informing distributors and customers about price changes. Consumers too, reduce their search time for better deals and conserve the pace of economic activity. Creeping inflation also provides a supportive environment for investments and entrepreneurship. The predictability in prices allows individuals to plan their investment portfolios accordingly, fostering economic growth. Thus, the benefits of low inflation exceeds its costs as it signals growth and prosperity and encourages entrepreneurship.
Inflation is often problematic except in economies where it is low or decreasing over the years and unemployment is high or on the rise. Governments may sacrifice the objective of controlling inflation in such situations and emphasize on fostering economic growth. They may remain focused on reducing unemployment even if the general price level gradually increases during the process. However, there is little doubt to the fact that a high inflation rate does not only raise cost of living but also hampers investments and economic growth.