Inflation Effect

The economic effects of inflation are all pervasive. It affects all those who depend on the market for their livelihood. The effects of inflation may be favorable or unfavorable, and low or high depending on the rate of inflation. For example a galloping the hyper inflation has devastating effect on the economy and have serious social and political implications too. Certain major aspects of the economy are (i) distribution of income, (ii) distribution of wealth, (iii) different sections of the society, (iv) output and economic growth, and (v) employment of labour.


1. Effect of inflation on distribution of income: - the effect of inflation on income distribution depends on how it affects the price received and price paid by different sections of the society especially the consumers and the producers. Prices received are the same as income defined crudely. For example, households receive their income in the form of factor prices- wages and salaries, rents and royalties, dividend, interest profits and income from self-employment similarly, actual prices paid represent the expenditures on consumer goods and production imputes. Inflation changes the income-distribution=-pattern only when it creates a divergence between total price received and total prices paid by different section of the society. 

2. Effect of inflation on distribution of wealth: - from the view point of analysis here. Let us look at wealth as accumulated assets. Assets can be classified as: (i) price variable assets, and(ii) fixed value assets, price-variable assets are those whose prices change with change in the general rice level. The money value of price-variable assets increase, during the period of inflation. Price-variable assets can be further classified as; (a) physical assets including land, building, automobiles, gold jeweler etc. and (b) financial assets including shares and stocks. The fixed-value asses, on the other hand, are those assets whose money value remains constant even if the general price level changes. Fixed-value assets include bonds, term deposits with banks and companies, loans and advances, etc, like assets, there are liabilities also, liabilities are mostly fo fixed claim nature like house loans, car loans, bank loans, and mortgage of property. Let us assume, for the sake of simplicity in the ansalysis that fixed value assets and fixed value liabilities cancel out. 

Empirical evidence: - 
in has been argues above that inflation can, at least theoretically, affect the distribution of income and wealth under certain conditions. Let us now turn to the question whether inflation really affects income and wealth distribution. The economists have devoted a considerable effort and attention to examine the effect of inflation on the distribution of wealth. A voluminous literature is available on the subject. Empirical studies do not produce conclusive evidence on the effect of inflation on the distribution of income and wealth. To quote Samuelsson and nordhaus, the summary wisdom of these studies indicates that the overall impact is highly unpredictable.

3. Effects of inflation on different sections of society: - 
wage earners it is cannon belief that wage earners are hurt by inflation. Some authors consider this belief as a myth. In fact, whether wage earners lose or gain by inflation are again labour- market conditions. In developed countries labour is by and large, organized and labour market is competitive. According to baumol and blinder the average wage typically rises more or less in step with prices. This contradicts the popular myth that wage earners are, in general, losers during the period of inflation. They have used US date to show that real wage is not systematically eroded by inflation. They add, the fact is that in the long-run, wages tend to outstrip prices as new capital equipment and innovating increase output per worker. 

Producers: - whether producers gain or lose due to inflation depends, at least theoretically, on the rebates of increase in prices they receive (the sale price) and the prices they pay (input prices or the cost of production). In general, product prices rise first and faster than the cost of production, therefore, profit margin increases and producers gain.

Fixed income class: - the people of the fixed-income category are the not losers during the period of inflation. The reason is that their income remains constant even during the period of inflation but the prices of goods and services they consume increase. As a result, the purchasing power of their income fats eroded in proportion to the rate of inflation. For example, suppose that a person earns a fixed annual income of $100,000 and that the rate inflation is 10 percent. It means that if he spends his total income, he can buy goods and services worth only $90, 00 at the prices in the current yea. If prices continue at the rate of 10 percent per annum, his purchasing power will be reduced to goods and services worth $81,000 in the second year and to worth $72,900 in the third year, and so on. 

Borrowers and lenders: -
 in general borrowers gain and lenders lose during the period of inflation. For example, suppose a person borrows $5 million at 12 percent simple rate of interest for a period of five years to buy a house. Suppose also that escalation in property prices is such that property prices double every 5 years. After 5 years, the borrower would pay a total sum of $ 8 million whereas the price of house rises to $10 million, the borrower gains by $2 million. The lender loses by the same amount in the sense that had he bought the house himself, his asset value would have risen to $10 million. 

The government: -
 the government is a net gainer during the period of inflation. In order to analyze the government's gain form inflation let use consider the government as a taxing and spending unit and as a net borrower. As regards the effects of inflation on tax revenues, inflation increase revenue yields from both the direct and indirect taxes. Consider first the direct taxes, viz personal and corporate income taxes. 

4. Effect of inflation on economic growth: -
 the effect of inflation on economic growth can be examined at both theoretical and empirical levels. Let us first examine the issue of inflation and economic growth at theoretical level. Theoretically, the rate of economic growth depends primarily on the rate of capital formation which depends on the rate of saving and investment.

First: - during the period of inflation there is a time-lag between the rise in output prices and rise in input prices, particularly the wage rate. This time-lag between the rise in output prices and the wage rate is called wage-lag. Then the wage-lag persists over a long period of time,, it enhances the profit margin. The enhanced profits provide both incentive for a larger investment and also the investable funds to the firms. Firms plough back their profits for higher profits. This results in an increase in investment, production capacity and a higher level of output.

Second: - inflation tends to redistribute incomes in favour of higher income-groups whose income consist mostly of profits and non-wage incomes. This kind of inflation-induced redistribution o fin comes increase total saving because upper-income groups have a higher propensity to save. The increase in savings increases the supply of investable funds and lowers the rate of interest. Since investment, with increase in investment, production capacity of the economy increase. This causes an increase in the total output, which means economic growth. 

Conclusion: - most economists generally agree that a moderate rate of inflation is conducive to economic growth and that, in the short run, there is positive relationship between moderate rate of inflation and economic growth. In the words of Samuelsson and nordhaus, while economists may disagree on the exact target for inflation most agree that a predictable and stable or gently rising price level provides the best climate for healthy economic growth. 

5. Effect of inflation on employment: - economic growths the employments go hand in hand. It may thus be construed that inflating has promotional effect on employment. It is a widely accepted view that a moderate rate of inflation helps economic growth which creates additional employment opportunities. Since inflation affects growth variables-savings, investment and profits-favorably, it affects employment favorably too. The economists have found that the greater the rate of investment the greater the rate of employment till the economy reaches the full employment level. 

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