The Consequences of Inflation
Fall in the Value of Money
- Whether a household’s purchasing power actually decreases, however, depends on whether their income rises above the rate of inflation
Menu Costs
- These are the costs of changing prices due to inflation
Shoeleather Costs
- During times of high inflation, if money’s lying around, it’s losing value
- Time and effort therefore has to be taken in finding out where the money can gain the most interest in terms of which financial institutions/banks to put it in
- This time and effort is seen as a ‘cost’
Administrative Costs
- Things like negotiating new wage rates of adjusting accounts take time and effort
Inflationary Noise
- This is the distortion of price signals by inflation
- g. if the price of a TV rises, it would be hard to tell if it’s a relative price rise or it’s just a price rise that’s in line with inflation
Fiscal Drag
- This would occur when people’s income is dragged into higher tax bands due to tax brackets not changing in line with inflation
Uncertainty
- If firms are uncertain about what costs will be and what revenue they can take, they may be reluctant to invest
- Likewise, uncertainty also means that households will find it difficult to decide how much and when to save.
Inflation Causing Inflation
- If consumers think that prices are going to rise in the future, then they’ll spend more in the present, which will then increase AD
Loss of International Competitiveness
- If the rate of inflation in a country is higher than its competitors, its goods and services will be less price competitive
- This is likely to result in fewer exports sold and more imports being purchased.