The following points highlight the six major effects of inflation. The effects are: 1. Effects on Distribution of Income and Wealth 2. Effects on Production 3. Effects on Income and Employment 4. Effects on Business and Trade 5. Effects on the Government Finance 6. Effects on Growth.
1. Effects on Distribution of Income and Wealth:
The impact of inflation is felt unevenly by the different groups of individuals within the national economy—some groups of people gain by making big fortune and some others lose.
We may now explain in detail the effects of inflation on different groups of people:
(a) Creditors and debtors:
During inflation creditors lose because they receive in effect less in goods and services than if they had received the repayments during a period of low prices. Debtors, on other hand, as a group gain during inflation, since they repay their debts in currency that has lost its value (i.e., the same currency unit will now buy less goods and services).
(b) Producers and workers:
Producers gain because they get higher prices and thus more profits from the sale of their products. As the rise in prices is usually higher than the increase in costs, producers can earn more during inflation. But, workers lose as they find a fall in their real wages as their money wages do not usually rise proportionately with the increase in prices. They, as a class, however, gain because they get more employment during inflation.
(c) Fixed income-earners:
Fixed income-earners like the salaried people, rent-earners, landlords, pensioners, etc., suffer greatly because inflation reduces the value of their earnings.
The investors in equity shares gain as they get dividends at higher rates because of larger corporate profits and as they find the value of their shareholdings appreciated. But the bondholders lose as they get a fixed interest the real value of which has already fallen.
(e) Traders, speculators, businesspeople and black-marketers:
They gain because they make more profits from the persistent rise in prices.
Farmers also gain because the rise in the prices of agricultural products is usually higher than the increase in the prices of other goods.
Thus, inflation brings a shift in the pattern of distribution of income and wealth in the country, usually making the rich richer and the poor poorer. Thus during inflation there is more and more inequality in the distribution of income.
2. Effects on Production:
The rising prices stimulate the production of all goods—both of consumption and of capital goods. As producers get more and more profit, they try to produce more and more by utilising all the available resources at their disposal.
But, after the stage of full employment the production cannot increase as all the resources are fully employed. Moreover, the producers and the farmers would increase their stock in the expectation of a further rise in prices. As a result hoarding and cornering of commodities will increase.
But such favourable effects of inflation upon production are not always found. Sometimes, production may come to a standstill position despite rising prices, as was found in recent years in developing countries like India, Thailand and Bangladesh. This situation is described as stagflation.
3. Effects on Income and Employment:
Inflation tends to increase the aggregate money income (i.e., national income) of the community as a whole on account of larger spending and greater production. Similarly, the volume of employment increases under the impact of increased production. But the real income of the people fails to increase proportionately due to a fall in the purchasing power of money.
4. Effects on Business and Trade:
The aggregate volume of internal trade tends to increase during inflation due to higher incomes, greater production and larger spending. But the export trade is likely to suffer on account of a rise in the prices of domestic goods. However, the business firms expand their businesses to make larger profits.
During most inflation since costs do not rise as fast as prices profits soar. But wages do not increase proportionate with prices, causing hardships to workers and making more and more inequality. As the old saying goes, during inflation prices move in escalator and wages in stairs.
5. Effects on the Government Finance:
During inflation, the government revenue increases as it gets more revenue from income tax, sales tax, excise duties, etc. Similarly, public expenditure increases as the government is required to spend more and more for administrative and other purposes. But the rising prices reduce the real burden of public debt because a fix sum has to be paid in instalment per period.
6. Effects on Growth:
A mild inflation promotes economic growth, but a runaway inflation obstructs economic growth as it raises cost of development projects. Although a mild dose of inflation is inevitable and desirable in a developing economy, a high rate of inflation tends to lower the growth rate by slowing down the rate of capital formation and creating uncertainty.
But inflation, especially a runaway inflation, is an unstable situation. It makes the business world uneasy and uncertain. Society gets disturbed as there grows discontentment among the salaried people and they demand an increase in their wages and salaries.
The middle-class people suffer hard as the real value of their income becomes very low. Inflation is also unjust as it makes one class of people richer and the other poorer. But the most serious effect of inflation from the standpoint of the economy is that it makes the economic environment of business unstable.