Analyse the effects of inflation on an economy

Inflation impacts on many facets of the economy, these impacts can be both long and short term. It is generally the case that higher levels of inflation carry more severe consequences thus it is often the aim of government to sustain a low level of inflation. Inflation effects economic growth and certainty, wages, unemployment, international competitiveness, exchange and interest rates amongst other things.

High inflation can be a major constraint on economic growth and certainty which ultimately impacts upon international competitiveness. High inflation distorts economic decision making as producers and consumers change their spending and saving patterns to minimise the potential impact of inflation upon themselves. High inflation means consumers are more likely to spend their money rather than save due to the purchasing power of their money reducing over time, on the other hand business investment is discouraged as future profit levels become uncertain. This lack of business investment results in increased export prices and thus reduced international competitiveness and quantity of exports, simultaneously consumers are more likely to switch to import substitutes, worsening the trade deficit. On the contrary however, low inflation leads to increase in business investment and consumer saving leading to the improvement of international competitiveness, making Australian products more attractive for purchase. Ultimately lower inflation rate leads to positive impacts upon economic growth, creates a greater sense of certainty, leads to an expansion of exports and replaces imported substitutes with domestic products, thus improving the trade deficit. Thus from this we can draw out that the implications of high inflation impacts negatively whilst lower inflation can hold many positive consequences for the economy.

The level of inflation has major impacts on both the level and the distribution of incomes. Nominal wage demands are majorly influenced by the level of