How Inflation Affects Function of Money

Topics: Inflation, Money, Store of value Pages: 2 (678 words) Published: February 28, 2013
Inflation is defined as a persistent increase in general price level. Inflation is measured by the proportional changes over time in some appropriate price index, commonly a consumer price index. General Price level refers to an average of all price in an economy and changes in reflect in the cost of living.

Inflation however affects many thing one being function of money such as medium of exchange, store of value, unit of account and standard of deferred payments.

Medium of exchange means that any item that is widely acceptable in exchange of goods and services. The existence of a medium allows trade to take place without the need for a joint coincidence of wants. A medium of exchange facilitates economic transactions. As long as the same money is going to be accepted as payment, inflation will not affect this function. But in extreme cases of inflation, people may lose confidence in money to the extent that they don't trust it, and resort to barter or some other means of conducting transactions.

Another function of money is store of value. If asset prices are stable, money is unattractive as a store of value, as it brings in no income, but if asset prices are unstable it may be worth holding some part of total assets in money, as a safeguard against risk. This is the one that inflation obviously affects the most. Inflation erodes the value of money; it does not keep its value. Something that costs a certain amount today will cost more tomorrow. This affects everything from the timing of transactions to the amount required for future payments (interest rates).

One of the roles of money is to be the unit of account in which contracts are expressed and individual incomes or firms’ profits are measured. High and fluctuating rates of inflation interfere with the performance of money as a unit of account, which is believed to be bad for the efficiency and equitable running of the economy. Inflation affects this function in two ways: different prices...
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