Inflation

Topics: Inflation, Monetary policy, Interest rate Pages: 2 (473 words) Published: March 20, 2013
INFLATION
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time. When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also decrease the purchasing power of money. Effects of Inflation on economy

1. Decrease Production: People buying less of goods and services as their income is limited. This leads to slowdown not only in consumption but also production. This is because manufactures will produce fewer goods due to high costs and anticipated lower demand. 2. Increase in interest rates: This makes borrowing costly for both consumers and corporate. So people will buy fewer automobiles, houses and other goods. Industries will not borrow money from banks to invest in capacity expansion because borrowing rates are high. 3. Unemployment: Higher interest rates lead to slowdown in the economy. This leads to increase in unemployment because companies start focusing on cost cutting and reduces hiring.. 4. Higher wages: Rising inflation can prompt trade unions to demand higher wages, to keep up with consumer prices. Rising wages in turn can help fuel inflation 5. Reduce Investment: Uncertainty over future inflation may discourage investment and savings. 6. Hoarding: If inflation is rapid enough, shortages of goods as consumers begin hoarding out of concern that prices will increase in the future * A positive effect of inflation is that central banks can adjust nominal interest rates  and encouraging investment in non-monetary capital projects. Causes of Inflation

1. Over-expansion of money supply: excess liquidity in the economy leads to inflation because “too many money would be chasing too few goods”. 2. Expansion of Bank Credit: Rapid expansion of bank credit is also responsible for the inflationary trend in a country. 3. Deficit Financing: The high doses of deficit financing which may cause reckless spending, may also contribute to the...
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