Inflation
Inflation is a worldwide phenomenon. It is the constant increase in general prices. It affects the economy of each country. Inflation has a negative impact on the economy and influences the overall people's wellbeing. Economists have initiated and analyzed several policies that can control the inflation and minimize its negative impact.
There are several costs to the economy that are a direct result from
periods of inflation. These include resource misallocation, capital
misallocation, transaction cost such as shoeleather costs and menu
costs, arbitrary redistribution of wealth and income, tax liabilities,
increased uncertainty, confusion and inconvenience. Each of these will
be elaborated on throughout the paper. These costs not only have
unfavorable impacts on business's and individuals but also adversely
effect the economy as a whole. Many of the costs identified however,
cannot be quantified or measured with and certainty. This factor has
and will continue to understate the validity of results generated
through the research and efforts of economists in their quest to find
the "true" costs of inflation to the economy. There is evidence that
does detail the adverse impacts of inflation to the economy, namely in
the areas of economic growth, resource efficiency, productivity,
investment and employment. It s simply a case where the exact costs
are unknown.
A price level characterized by in stability can lead to great
uncertainty in the economy. If the inflation level of a country is
volatile and varying on a continuous basis then the level of
investment, consumption and economic growth are likely to be impeded.
The rationale for this, supported through historical reference, is
that in such a case, firms become increasingly reluctant to invest in
new plant and equipment. This reluctance is derived from uncertainty
about the direction of the economy and the possible actions of the
Government in future periods. Consumers may also become hesitant or
less inclined to spend as a result of the uncertainty. Each of these
outcomes is capable of reducing the level of economic growth. The
magnitude of this possible reduction is not only dependent on the rate
of inflation but also factors other related economic indicators.
Through historical reference and other research forms, evidence of a
misallocation of resources resulting from inflation and inflation
uncertainty has arisen. One such example of resources being
misallocated can be attributed to the distorting effects that
inflation can have on the price system. The decision making process of
business's is one based and evaluated against the backdrop of the
firm's money flows. Indicators such as revenue, costs of inputs,
profit levels etc. are assessed before decisions of any significance
can be made. These decisions are therefore a function of information.
The more accurate the information available to the business, the
better educated they are to make the right decision so as to achieve
the most efficient outcome or desired result. Inflation causes prices
to change more frequently and in occurs in ways that distort the
market's network of information. The market's information system can
best be characterized as a system of relative prices. If the
individuals that bare the responsibility of making decisions
misinterpret prices then they are in a position capable of
misallocating resources and capital from there most efficient use. In
this case resource misallocation could either involve producing too
much or too little of the good subsequent to the misreading of the
true relative price of the good in question. The m0isallocation of
resources can also be represented through the potential outcome of
buying too much of one input or too little of another based on the
reasoning or perception that one appears to be 'cheaper'than the
other. These types of outcomes are a common occurrence in the economy
and reflect one of the more significant costs of inflation. The cost
itself impacts on the firm's productive efficiency and the potential
profits to be earned.
Inflation, through its effect on the price level also creates a cost
to the economy through increases in transaction costs. Within the
context of inflationary impacts there are two types of transaction
costs. These being shoeleather costs and menu costs.
Shoeleather costs refer to the costs that arise from engaging in a
greater level of financial transactions as the cost of holding lesser
amounts of money. These costs can be attributed to the decline in the
real value of money during periods of inflation. As the value of money
declines, individuals become more inclined to economise on their
personal holdings of money. The desire to hold cash on hand becomes
less attractive and alternative arrangements are sought. These include
equities, mutual fund shares, bonds that offer a higher rate of return
than money etc. the problems these individuals face or the costs they
endure stem from the fact that in order to carry out transactions they
will require money. The resulting outcome from this is that
individuals expend greater time and money through their involvement in
a series of financial transactions. This process involves transferring
funds from illiquid accounts into liquid accounts so as to enable them
to make payment. This process consumes both time and effort and in
some cases will also involve some monetary cost.
Menu costs are more of a direct cost to businesses and refer to the
costs associated with changing the prices of that particular
business's goods. Businesses are conscious of changing their price as
it can be a costly procedure and as a result try to make changes as
infrequently as possible. The procedure can often involve either
entering new prices into the computer system, attaching new price
stickers, printing new product catalogues or in the case of
restaurants /caffes', changing the menu. Each of these involves some
cost to the business. Periods of inflation lead to greater price
volatility and price changes which subsequently lead to business's
changing their prices more frequently and thus at a greater cost to
them.
Periods of inflation will have an effect on the distribution of income
and wealth in the economy with a costs represented through the nature
of the distribution process, with inflation present characterized by
arbitrary distribution. The reasons why and the process at which this
occurs is the result of many people having an income structure on
fixed terms. The relationship between income and inflation is that in
times of high inflation the less the worth of these fixed incomes.
This effect can also work with relation to the income itself changing
relative to the amount in which the inflation rate changes. It is
these effects that arbitrarily redistribute wealth and income to the
economy. Whilst there will be people that do gain from this process,
again or function of the movements in the inflation rate, it is those
individuals that lose out that bare the costs of inflation through no
fault of there own. There is a cost that can result out of the general
economic unhappiness that this creates in the area of greater
Government involvement or at least requests for this. It is the people
that have been treated unfairly that push for new legislation that
will ease their pain through an endeavor to create greater equality in
the outcomes. In this way, inflation can grind down the rule of law
that is an integral and very important aspect of a productive, growing
economy. Private contracts, which through the forces of inflation, are
subject to arbitrary losses (or gains) will give way to the actions of
Governments and their agenda's aimed at producing particular results.
It is not uncommon for countries to emerge from inflationary periods
with a more regulated and less efficient economy than before.
About the Author: The article was produced by the writer of masterpapers.com.
Sharon White is a senior writer and writers' consultant in philosophy term paper writing.
Get some useful tips for
dissertation proposal writing and
persuasive research paper writing.
More articles by Sharon White
Print Article | Download PDF | 381 views | May 12 2007
|
|
