Effects of Inflation Md. Nuruzzaman, Ph.D. Director (Training), NAPD 1

2 Effects of Inflation  Impact on Output - In general inflation has major costs for the economy, the producer and the consumer.

3 Effects of Inflation  Inflation causes productive investment to fall because profitability falls, speculative investment rises which has a negative effect on employment, output and income. Inflation causes resources to be misallocated.

4 Effects of Inflation  Inflation causes uncertainty to increase which can erode business and consumer confidence.  The drop in confidence can reduce investment and consumption which produce downward pressure on employment and production.

5 Effects of Inflation  Inflation leads to domestic interest rates increasing. Like other prices, the price of money rises to compensate suppliers of money (lenders/savers) for the falling value of the dollars they are repaid. This reduces investment and consumption leading to negative effects on employment and output.

6 Effects of Inflation  If inflation rate is greater than overseas inflation rates, exports decrease and imports increase. This reduces output and employment. Inflation makes a country less internationally competitive, the Current Account deficit also rises.

7 Effects of Inflation  Government may tighten fiscal and monetary policies to reduce inflation, thus causing unemployment to rise and production to decrease.

8 Effects of Inflation  Inflation causes a redistribution and reallocation of resources to the following groups:  Speculators  Borrowers/Lenders  Strong Employee Groups in Key Industry  Monopolies / Oligopolies in Key Industries  Government

9 Effects of Inflation  Speculators: buy and sell property, collectables (eg: art precious metals) etc. during inflationary periods because these items rise faster in price than the general price level which results in Speculator’s real income increasing.

10 Effects of Inflation  Borrowers/Lenders - (depending on interest rates): borrowers benefit if the inflation rate is greater than the interest rates. They pay back dollars of less value and lenders lose.

11 Effects of Inflation  Strong Employee Groups in Key Industries: can use industrial ‘muscle’ to gain wage/fee increases greater than other groups of employees and the inflation rate ( distributive affect).

12 Effects of Inflation  Monopolies / Oligopolies in Key Industries: can raise their prices ahead of inflation and / or pass on cost increases to consumers to maintain or raise profits (distributive effects).

13 Effects of Inflation  Government: revenue rises due to bracket creep, ie: inflation lifts people into higher income and marginal tax brackets, where they pay a higher proportion of income tax to the government.

14 Effects of Inflation  Inflation causes a redistribution and reallocation of resources away from the following groups:  Fixed Income Earners  Weak Union or Non-union Sections of the Workforce  Borrowers/Lenders  Firms in Highly Competitive or Depressed Industries  Savers

15 Effects of Inflation  Fixed Income Earners: real incomes decrease as changes to money incomes lag well behind inflation e.g: the unemployed, public servants etc.

16 Effects of Inflation  Weak Unions or Non- unionised Sections of the Workforce: their money incomes fall behind inflation because they lack industrial ‘muscle’.

17 Effects of Inflation  Borrowers/Lenders (depending on interest rates): borrowers lose if interest rates move ahead of inflation. Lenders anticipate inflation and raise rates to protect real returns.

18 Effects of Inflation  Firms in Highly Competitive or Depressed Industries: rising costs reduce profits when firms cannot easily raise prices.

19 Effects of Inflation  Savers: savings in conventional low interest bank deposits lose value.

20 Effects of Inflation  Conclusion: Inflation transfers income between competing income groups. It causes a redistribution of income away from weaker, low income earners to more protected high earners in both private and public sectors.

21