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Effect of Inflation
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This lesson provides the different effects of inflation on the economy of a country

Awdhesh Singh is teaching live on Unacademy Plus

Awdhesh Singh
Director,, An E-learning platform for Civil Services, Schools, GST etc., IITian, Former IRS Officer CSE-1989 rank 272

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  1. Effects of Inflation Dr Awdhesh Singh, IRS (Retd.) Director, Awdhesh Academy, Former Commissioner, Customs & Indirect Taxes (Central Excise/GST)

  2. 1. Erodes Purchasing Power Inflation is a decrease in the purchasing power of currency due to a rise in prices across the economy. If the inflation is high, money loses its power very fast.

  3. Encourages Spending and Investing A predictable response to declining purchasing power is to buy now, rather than later. Cash will only lose value, so it is better to get your propabig wut ct the valuend stock up on things that probably won't lose value. It means for consumer filling up gas tanks, stuffing the freezer, buying shoes in the next size up for the kids, and so on. For businesses, it means making capital investments that, under different circumstances, might be put off until later. Many investors buy gold and other precious metals when inflation takes hold

  4. 3. Hyperinflation Unfortunately, the urge to spend and invest in the face of inflation tends to boost inflation in turn, creating a potentially catastrophic feedback loop. As people and businesses spend more quickly in an effort to reduce the time they hold their depreciating currency, the economy finds itself awash in cash no one particularly wants. Thus the supply of money outstrips the demand, and the price of money the purchasing power of currency falls at an ever-faster rate. People become desperate to offload currency and that creates hyper inflation Due to hyperinflation, Germans papered their walls with the Weimar Republic's worthless marks (1920s), Peruvian cafes raised their prices multiple times a day (1980s) and Zimbabwean consumers hauling around wheelbarrow-loads of million- and billion-Zim dollar notes (2000s)

  5. 4. Raises the Cost of Borrowing There is a strong relationship between inflation and interest rates. .If interest rates are low, companies and individuals can borrow cheaply to start a business, earn a degree and hire new workers. In other words, low rates encourage spending and investing .By raising interest rates, central banks can put a damper on spending as people prefer to put some money in the bank, where it can earn interest. When there is not so much cash following around, money becomes more scarce which increases the value of currency and control the inflation

  6. 5. Reduces Unemployment Inflation can push down unemployment. . At the time of the Great Depression in USA, unemployment surged because workers resisted pay cuts and were fired instead . The same phenomenon may also work in reverse: wages' upward stickiness means that once inflation hits a certain rate, employers' real payroll costs fall, and they're able to hire more workers.

  7. Inflation and Unemployment Inflation and unemployment Unemployment Core CP 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% Jan 1998 Jan 2002 Jan 2006 Jan 2010 Jan 2014 Jan 2018 Core CPI year-over-year change and seasonally adjusted unemployment rate Source: BLS Created with Datawrapper

  8. 6. Increases Growth .Inflation discourages saving, since the purchasing power of deposits erodes over time. This gives consumers and businesses an incentive to spend or invest. At least in the short term, the boost to spending and investment leads to economic growth Inflation's negative correlation with unemployment implies a tendency to put more people to work, spurring growth.

  9. 7. Reduces Employment and Growth High inflation can reduce employment and growth. When inflation is very high, cost of funds increases for businesses and this leads to drop in the industrial and business activities in nation. This lead to drop in the employment and thus growth as the production and supply of goods and services declines. *A healthy rise in prices-2% or even 3% per year would do more good than harm. When growth is slow, unemployment is high and inflation is high.

  10. 8. Weakens the Currency High inflation is usually associated with a slumping exchange rate, though this is generally a case of the weaker currency leading to inflation, not the other way around. Economies that import significant amounts of goods and services must pay more for these imports in local- currency terms when their currencies fall against those of their trading partners. . Thus high inflation in the country weakens the currency value as compared to the international currency