Effects of inflation

Topics: Inflation, Macroeconomics, Investment Pages: 3 (715 words) Published: December 7, 2013
This rise in relative inflation leads to a fall in the world share of UK exports and a rise in import penetration. Ultimately, this will lead to a fall in the rate of economic growth and the level of employment.

The problems of a wage-price spiral – price rises can lead to higher wage demands as workers try to maintain their real standard of living. Higher wages over and above any gains in labour productivity causes an increase in unit labour costs. To maintain their profit margins they increase prices. The process could start all over again and inflation may get out of control.

Higher inflation causes an upward spike in inflationary expectations that are then incorporated into wage bargaining. It can take some time for these expectations to be controlled. Higher inflation expectations can cause an outward shift in the Phillips Curve.

Inflation can also cause a reduction in the real value of savings - especially if real interest rates are negative.

This means the rate of interest does not fully compensate for the increase in the general price level. In contrast, borrowers see the real value of their debt diminish. Inflation, therefore, favours borrowers at the expense of savers.

Consumers and businesses on fixed incomes will lose out. Many pensioners are on fixed pensions so inflation reduces the real value of their income year on year. The state pension is normally uprated each year in line with average inflation so that the real value of the pension is not reduced.

However it is unlikely that pensioners have the same spending patterns as those used to create the weights from which the RPI figure is calculated. For example in November 1999, the state pension was up-rated by just 1.1% - the headline rate of inflation for that month.

Inflation usually leads to higher nominal interest rates that should have a deflationary effect on GDP.

Inflation can also cause a disruption of business planning – uncertainty about the future makes planning...
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