THE IMPACT OF INFLATION
Inflation has different effects on different economic activities on both micro and macro levels. Some of these problems are considered below:
i. During inflation money loses value. This implies that in the lending-borrowing process, lenders will be losing and borrowers will be gaining, at least to the extent of the time value of money. Cost of capital/credit will increase and the demand for funds is discouraged in the economy, limiting the availability of investable funds. Moreover, the limited funds available will be invested in physical facilities which appreciate in value over time. It's also impossible the diversion of investment portfolio into speculative activities away from directly productive ventures.
ii. Other things constant, during inflation more disposable incomes will be allocated to consumption since prices will be high and real incomes very low. In this way, marginal propensity to save will decline culminating in inadequate saved funds. This hinders the process of capital formation and thus the economic prosperity to the country.
iii. The effects of inflation on economic growth have inconclusive evidence. Some scholars and researchers have contended that inflation leads to an expansion in economic growth while others associate inflation to economic stagnation. Such kind of inflation if mild, will act as an incentive to producers to expand output and if the reverse happened, there will be a fall in production resulting into stagflation i.e. a situation where there is inflation and stagnation in production activities.
iv. When inflation imply that domestic commodity prices are higher than the world market prices, a country's exports fall while the import bill expands. This basically due to the increased domestic demand for imports much more than the foreign demand for domestic produced goods (exports). The effect is a deficit in international trade account causing balance of payment problems for the country that suffers inflation.
v. During inflation, income distribution in a country worsens. The low income strata get more affected especially where the basic line sustaining commodities' prices rise persistently. In fact such persistence accelerates the loss of purchasing power and the vicious cycle of poverty.
vi. Increased production
It is argued that if inflation is of the demand-pull type, this can lead to increased production if the high demand stimulates further investment. This is a positive effect of inflation as it will lead to increased employment.
vii. Political instability
When inflation progresses to hyper-inflation, the unit of currency is destroyed and with it basis of a free contractual society.
viii. Inflation and Unemployment
For many years, it was believed that there was a trade-off between inflation and unemployment i.e. reducing inflation would cause more unemployment and vice versa.