COSTS OF UNEMPLOMENT AND INFLATION
In an economy both unemployment and inflation have adverse effects and policy makers formulate policy instruments to contain both the problems. The costs of unemployment at the macro level could be loss of potential output and wastage of valuable resources (manpower). At the household level it is a loss of income and consequent deterioration in standard of living of the household. It is difficult to measure the human cost of unemployment with precision as social stigma and psychological trauma of the problem are also involved. On the whole, policy makers and political leaders see to the fact that the cost of unemployment is minimal. Ideally the economy should not have a rate of unemployment higher than the natural rate of unemployment.
Inflation is defined as a situation of persistent price rise. While the rate of inflation varies over time and across countries there is much debate on permissible rate of inflation. While inflation rate has been moderately high in certain countries, there are instances of hyperinflation in some countries where rate of inflation has been more than 1,000 per cent per year (for example, Latin American countries in 1980s and former socialist economies in 1990s).
Inflation is widely considered as a social evil. Policy makers are always on the look out for price trend so that high inflation can be checked through appropriate policy measures. General public also are widely vigilant about price movements so that pressure can be exerted on the government if there is acceleration in inflation rate.
During inflation money loses its purchasing power and nominal costs of goods and services increase. Moreover, there is a reduction in real income of fixed income groups (salaried class, for example), as their income does not change at the same pace as price rise. When there is a price rise borrowers gain in fixed interest rate environment as the value money they return is lower than anticipated at the time of borrowing. On the other hand, lenders stand to lose as the value of money they receive after a lapse of time gets eroded. During periods of high inflation, there is fair chance that government revenue is much less than government expenditure resulting in huge fiscal deficits. In order to finance the deficit the government has three options: borrow from public, run down on foreign exchange reserve, and print money. Usually a government running huge deficit is already under heavy debt and paying a high amount of interest. Hence, further borrowing becomes difficult. Moreover, such governments also have low foreign exchange reserve and therefore, printing money becomes an easy option which fuels the rate of inflation fiuther. You can recall the Indian condition in 1990-91 when it was loaded with heavy debt, foreign exchange reserve was abysmally low and there was double-digit inflation. In general, high inflation put the economy out of gear aid it becomes difficult to maintain economic stability. When inflation is anticipated correctly then individuals take precaution and adjust their future paymentslreceipts keeping the rate of inflation in mind. However, unexpected inflation provokes income re-distribution between income groups. Usually the wage earning class who have a fixed nominal wage are the looser as real wage gets deteriorated due to price rise while profit earning class gain handsomely.