Fixed income earners lose out. Real incomeVariable income earners
relatively stable or real income(c)
When Prices , costs lag behind.Thus Profits for businessman at the expense of workers, creditors (income is fixed)(d)
Real Savings , thus, Inflation discourages savings
Effects on Production
-Mild Inflation may encourage greater production and Investment because of high expectedreturns. However if it is too rapid, business failures and unemployment may result.-Inflation may reduce efficiency in production. However, rising GPL may force some firms tobecome more efficient to survive.-Inflation reallocates resources because of the changed relative prices.
Effects on Government Finance
-Inflation the real cost of borrowing by the govt (as interest rates of govt bond is fixed)-Tax revenue as incomes, profits and prices . Budget surplus may result as govt revenuefaster than govt expenditure.-But benefits are short-
lived and can’t outweigh the costs of inflation.
Effects on the Balance of Trade (Current Balance)-During Inflation, prices , domestic goods become more expensive, thus X-Foreign goods become cheaper than local goods, thus M-This may lead to a trade deficit as (X - M)(b) Effects on Capital Balance- inflation rate, nominal interest rates, short term capital inflows. However,countries with high inflation rates are seen as economically unstable, long term capitaloutflows, FDI(c) Decrease in Balance of Payments and External Value of currency due to (a) and (b).(d) Increased costs of Foreign Debt Servicing as ER , more local currency is paid eventhough the amount in the foreign currency is the same.
Relationship between Money supply and Inflation
Equation of Exchange: MV = PYM = Money supply in the economy, V = Income velocity of circulationP = general price level expressed as an index, Y = real value of national income
Fisher’s Equation of Exchange: MV = PT
M PT = The number of transactions taken place in a year. Thus, PT = Total Spending