Negative Effects Of High Inflation

Fathima Samsudeen Discuss the Negative effects of high Inflation. Inflation by definition is the sustained increase in average general price level, this eventually causes the cost of living to become expensive and the value of money to decrease. There are several causes for inflation and although there are positive effects of inflation, I will be discussing the negative impacts on the economy in this essay. The first being the increase of unemployment, this is specifically due to cost push inflation (aggregate supply shifting to the left and so price level will increase). As if there is a there is a high cost of production, there is therefore a decrease in the demand for labour. This will ultimately lead to firms going out of business which means that more people will be made redundant. Government expenditure will increase as more money will have to be spent on benefits and there will be less tax revenue being collected. Due to the imbalance of government expenditure against government spending- this will lead to a budget deficit. Thus, there will be less funds available for economic welfare. As an example, there will be less spending on public facilities such as education and health care. (Refer graphs at the end of the essay) However, this is most likely to happen with cost push inflation. In the case of demand pull inflation (another cause of inflation due to the aggregate demand curve shifting to the right and therefore causing a higher price level), it is expected that the level of unemployment will decrease. As there is a higher level of aggregate demand, there will be an increase in the demand for workers to produce more goods and services. Therefore, budget deficit should improve because more people are working. Another negative effect of inflation is the lower standard of living. As the price level increases, there will be less purchasing power due to the low real income. Therefore, households will have to result to lower quality goods as the same choice can no longer be afforded. Consequently, some employees may have to work extra hours to compensate which will mean that they will have less time to spend on leisure. In other cases, some people may not be able to afford leisure activities that they could have prior to the inflation, such as the gym or vacations due to the increase in price level. Fixed income workers are particularly those who will be most affected by inflation, this includes pensioners and Interest earners. On the other hand, if wages are increased at the same pace as inflation then the real income will not be as affected and so stanciard of living may not decrease as much as anticipated. Moreover, high inflation could encourage people to demand foreign goods which might be cheaper, as a result there will be more variety available and a better living standard. The last negative consequence of high inflation is balance of payment deficit. This occurs as high prices means that the country is less internationally competitive and therefore there is less demand by foreigners which ultimately leads to a decrease in exports. Moreover, if domestic goods are expensive, people are more likely to buy from abroad, this will increase imports. A high level of imports and a decrease in exports will cause a balance of payment deficit. As exports are an injection and imports are a leakage, it will lower the circular flow of income and slower the growth rate due to the negative multiplier effect. However, this might not occur if there is a relative price as compared to other counties. People will not be as encouraged to spend abroad and will hence stick to domestic goods. Also, the country's trading partner may still continue buy goods from then. As even though there is inflation, products may still be cheaper here than buying from other countries, therefore exports will not be affected. Furthermore, people may be more focused on non-pricing factors such as the quality and so will still continue to purchase goods, this could eventually offset the effect of higher inflation. To conclude, I think that the most significant negative effect of high inflation is the increase of unemployment as this could ultimately lead to a budget deficit and the economy is less likely to develop. This is caused by cost push inflation, which I believe does more damage to the economy than demand pull inflation. As compared with demand pull inflation where at least growth is taking place. Also, an economy is better off with the low infiation as compared to deflation as deflation can discourage spending and delay consumption as compared to low inflation which can bring steady growth.