Effects of Inflation

Effects of Inflation

  • On Income Earners: Those on fixed incomes or assets in nominal terms lose. However, those on incomes which are directly related to the price level (real incomes) may remain relatively unchanged or may even increase.
  • On Production: Demand-pull inflation may lead to inefficiency in production since competitive pressures to improve both product and performance will be greatly reduced. Cost-push inflation, however, puts a premium on efficiency.
  • On Profits: Generally, profits increase when the inflation is the demand-pull type and decline when the inflation is the cost-push type.
  • On Foreign Trade: Rising domestic prices can hurt exports. If domestic prices are rising faster than the rest of the world prices, exports will fall and imports will tend to increase and this will invariably affect our net exports and may have devastating balance of payment implications.
  • On Lenders and Borrowers: Inflation tends to encourage borrowing and discourage lending. This is because what is borrowed today which could have been used to purchase, say a bowl of rice today, would not enable the creditor to purchase the same bowl of rice when the loan is paid back. This is true only when nominal interest rate is fixed or rises at a slower pace than inflation.

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