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Module 1: Types of inflation

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Effects of inflation

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XSIQ
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Economics - Effects of inflation

Effects of inflation

Inflation affects three main areas:

* _Resource allocation._ The pattern of resource allocation is distorted.
Speculative investment in things like real estate, antiques and artwork
become popular, as their value tends to go up faster than inflation.
Productive investment in capital goods is discouraged, as there is now
greater uncertainty and, therefore, risk.

* _The share of income and wealth is changed. _Some groups 'win' at the
expense of others who 'lose'. Those who tend to benefit from inflation
include borrowers of funds as the value of their repayments diminishes over
time. Those who have market power, including strong trade unions and
businesses, that have very little competition; and the government, who gain
from bracket creep as workers move into higher tax brackets.

* _External stability._ a countries inflation rate is higher than that of
its trading partners, reduced international competitiveness [1] leads to
external instability. The demand for exports falls and local demand for
imports increases. The trade deficit (where M is greater than X) rises.

The benefits of achieving low inflation include the following factors:

* improved international competitiveness, as Australian goods and
services become relatively cheaper

* a reduction in the trade deficit, as there will be more sales of goods
and services

* higher levels of investment, as business becomes more confident

* inflationary expectations are reduced, helping to maintain a low
inflation environment.

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Links:
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[1] http://alison.com/#