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The Effects of Inflation

Updated on November 11, 2013

Effects of Inflation

Inflation is not considered bad so long as it creates additional employment to the factors of production.  It becomes bad the moment it goes out of control.  Inflation may be compared to a robber.  It deprives the victim of some possession with the difference that robber is visible, inflation is invisible.  The robber's victim may be one or a few at a time.  But the victim of inflation is the whole nation.  The robber may be dragged to a court of law but inflation is legal.  Inflation disrupts the economy and paves the way for social and economic upheavals, besides being highly demoralizing.

The entrepreneur faced with the demand for higher wages and trying to keep up with such a demand, a retired person trying to manage his living on a fixed pension, a person with fixed income meeting his needs of household expenditure by borrowing from banks and other financial organizations, and the housewife struggling hard to serve food in a period of rising prices are aware of the effects of inflation with out being told about it.

Effects of inflation on distribution: Inflation has the effect of redistributing income because prices of all factors do not in the same proportion.  Entrepreneurs stand to gain more than wage earners or fixed income groups.  Speculators, hoarders, black marketers and smugglers gain on account of windfall profits.  Change in the value of money also result in the redistribution of wealth, partly because during inflation there is no uniform rise in prices and partly because debts are expressed in terms of money.  Inflation is a kind of hidden tad, highly harmful to the poorer sections of society.  Thus, poor become poorer.

Effects of inflation on wage earners:   Wage earners generally suffer during inflation, despite the fact that they obtain a wage rise to counter the rise in the cost of living.  However, wages do not rise as much as the rise in price of those commodities which the workers consume.  Further, wages are allowed to rise much later than the rise in prices.  Thus, there is a lag between the two, which works to the disadvantage of the worker.  If the workers are organized, they may not suffer much during inflation but if they are unorganized like the agricultural laborers they may suffer more as they may not find it easy to get their wages increased.

Effects of inflation on middle class and salaried persons:
   The hardest hit are the persons who receive fixed income, usually called the middle class.  Persons who live on past savings, fixed interest or rent, pensions, salaries etc., suffer during periods or rising price as their incomes remain fixed.  The middle class who by hard work take care of children's education, livelihood in the times of sickness and old age and accommodate day to day expenses find it difficult to survive the times of serious inflation.

Effects of inflation on public morale:  inflation result in arbitrary redistribution of wealth favoring businessmen and debts, and hurting consumers, creditors, petty shop-keepers, small investors and fixed income earners.  This lowers the public morale.  The ethical standards and the public morale falls to miserably low levels during the period of hyper-inflation.

Effects of inflation on debtors and creditors: Debtors borrow from creditors to repay with interest at some future date.  Changes in price level effect them differently at different time periods.  During inflation when the prices rise and the real value of money goes down, the debtors pay back less in real terms than what they had borrowed and thus, to that extent they are gainers.  On the other hand, the creditors get less in terms of goods and services than what they had lent and lose to that extent.

Effects of inflation on Farmers: The price of farm products go up faster than costs.  Costs lag behind prices of product received by the farmers.  It has been observed in India that inflationary tendencies during war and post-war periods have helped farmers in paying off their old debts.  Moreover, farmers are generally debtors and have to pay less in real terms, while the land revenue, taxes, etc., do not rise much.  Thus farmers generally gain during the periods of inflation.

Effects of inflation on the entrepreneurs:
  When prices rise, producers, traders, speculators and entrepreneurs gain on account of windfall profits because prices rise at a faster rate than the cost of production.  Besides, there is time-lag between the price rise and the increase in cost. Moreover producers gain because the prices of their stock go up due to inflation.  Also they generally being borrowers of money for business purpose, stand to gain.

Effects of inflation on Investors:
  Different kinds of investors are affected differently by inflation.  An investor may invest in bonds and debentures which yield a fixed rate of interest or in real estate or equities (shares) whose returns (dividends) rise and fall with profits earned by the companies concerned.  When prices rise, the returns on equities go up on account of the rise in profits, while the bond and debenture holders gain nothing as their income remains fixed.  By the same logic, holders will lose during depression, while the debenture and bond holders gain.

Effects of inflation on Government
: In a mixed economy, the public sector is affected by fluctuations in price level.  As prices rise, the Government has to spend more on goods and services, including raw materials, for carrying through their projects.  Estimates are revised and taxes are raised during the period of inflation.


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