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To What Extent Is Inflation Damaging To The Economy? 18

1048 words - 5 pages

To what extent is inflation damaging to the economy? 18

Inflation is a sustained rise in the average price level. Inflation is measured in two ways the CPI and the RPI. CPI is a measure of the price level used across the European Union and used by the bank of England for setting its inflation target which is currently at 2%, it is calculated using a weighed basket of goods. This basket contains 650 goods. 100,000 households buying patterns of the goods in the baskets are recorded and the inflation rate is calculated through these figures. Maintaining a stable and anticipated inflation rate is a key government objective as it allows them to plan government spending for the future.

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Another cost is that of ‘shoeleather costs’ this relates to the costs involved in reducing holdings of cash and money and trying to find the highest rates of interest. During high inflation people cannot afford to let their money lose its value with the banks low interest rates, they therefore move their money around to find the best was to increase the value of their money, this involves a lot of time, this time could otherwise be spent increasing output and is therefore a major problem of inflation.
‘Wage spiral’ is another consequence of inflation, this is when prices rise and workers then demand a rise in pay, the firms then agree but the raise prices again to compensate for the rise in costs of production, this then continues to happen in a ‘spiral effect’ which is very damaging for those in a weak bargaining position (those with little value to the firms) who will not see an increase in pay and those on fixed incomes such as pensioners who would then see a fall in their living standards because of this major problem of inflation caused by cost push inflation.

However there are some possible benefits of inflation, this is only if there is a low and stable rate of demand pull inflation as a steady rise in price level may encourage firms to invest and therefore increase output. Workers also like rises in pay, even if matched by higher prices, with real pay staying the same. Psychologically they feel better about themselves and appreciated by their employers even If it is only in monetary terms, they are happier and therefore consumer expenditure is likely to improve but this could cause a shift in aggregate demand and therefore increase inflation levels more. Inflation can also help the labour markets operate more efficiently, this is because they are able to cut their wprkers salary in real moetery terms and then employ more people therefore lower unemployment levels which is beneficial to the economy as it takes people off benefits....

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