Tap to Read ➤

Effects of Inflation on the Economy

Maya Pillai Mar 10, 2020
How badly an economy is affected by inflation depends on its level at the time. Here is an overall idea about the impact of inflation on the economy.
"Austerity measures" and "Inflation", are being spoken of a lot these days, and it makes one wonder what these are, and how they are related to our daily lives. Well, inflation, as you may have some idea, is an overall surge in the prices of goods and services occurring over a relatively short period of time.
The demand for goods and services rises and the corresponding supply of the same cannot be kept up at the same pace. The reasons for such a rise are many and varied, but the result of such a situation is always the same - inflation.
Inflation affects everybody and it poses a threat to the economic stability of a nation. If you check global market history, you would understand that most countries have had to contend with inflation at some point.
For instance, after World War I, the German government lowered the value of their currency by printing massive amount of notes. And to buy a loaf of bread one had to spent a huge amount. The present downward trend in the world economies has resulted in a credit crunch and financial crisis.
When inflation affects an economy, to maintain the same level of living standards you have to pay more. Due to the rise in prices, you have to shell out more money to obtain the same amount of goods and services than you did prior to the inflation.
At the time of inflation, financial planning becomes difficult. The reason - the value of money decreases with inflation. It affects certain groups more than others such as the pensioners, compared to those who are currently employed.
Inflation often provokes organized groups of employees, such as those represented by the trade unions, to demand a pay rise. However, such a rise may increase spending, leading to further price increases. It becomes a vicious cycle, and is termed as the wage-price spiral.
People tend to save less in an economy affected by inflation because the price of services and goods are high. Interest rates and inflation have an inverse relation with one another.
Inflation is not necessarily a bad thing and its effects depend largely on whether it is low, moderate or high (hyperinflation). While hyperinflation is definitely a cause for alarm, low or moderate levels of inflation can have benefits like a salary hike.
Also, inflation favors borrowers as they have to pay the same amount borrowed before the onset of inflation - in effect, they pay less since the value of the same amount of money has declined. It is also believed that moderate inflation encourages investment in real assets, such as gold or realty.