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Consequences Of Inflation Essay

1016 words - 5 pages

Consequences of inflation
Inflation occurs when there is a sustained increase in the general level of prices and the purchasing power of money falls correspondingly. The government tries to control inflation as it is a major aim in their policies. For example, in the UK the government targets inflation at 2% per year and not zero inflation. Although hard to believe, inflation is actually beneficial for the economy overall and outweighs the costs. This happens only when the inflation rate is at low levels (approximately 2%-5 %.)
To begin with, a positive aspect of inflation is that a low rate increase in price levels allows greater flexibility in a growing economy and it also helps prices ...view middle of the document...

If someone borrows 100€ at a 5% interest and by the time he repays the inflation has risen over 5%, he will have gained in real terms. The person who lent the money will be worse off even if we include the interest he has received. This shows another cost of inflation which is that banks charge interest rates often higher than the rate of inflation. The creditors’ problem also applies for savers, who have deposited money in banks and other financial institutions. If the interest received is lower than the rate of inflation then the real value of their savings will fall.
Furthermore, another cost of inflation is that the loss of international price competiveness may cause balance of payment problems, or a current account deficit. Inflation encourages imports at the expense of exports and creates a deficit on the current account of the balance of payments. This is due to the fact that when there is inflation the exports of goods and services of a country seem more expensive and therefore their demand will lower. The imports, however, become relatively cheaper and more are likely to be imported, thus causing the current account deficit. Moreover, one of the most important costs is the fear of Unemployment. As the last point explained, when the firm of a country sells less abroad or domestically, less will be produced and some firms may even close down causing unemployment. Adding to that, inflation is a period of economic uncertainty, and business may be hesitant to invest in plant and machinery when the predictions of future profits and sales are uncertain. In addition, inflationary times cause pessimism in the business community and firms tend to delay their investment plans causing less goods and services to be produced which in the future will cause more unemployment. Furthermore, during inflationary times the real income of workers falls and the trade union leaders make demands on higher wages. Employers,...

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