Inflation has different effects on different economic activities on both micro and macro levels. Some of these problems are considered below:
a. During inflation money loses value. This implies that in the lending-borrowing prices, lenders will be losing and borrowers will be gaining at least to the extent of the time value of money. Cost of capital/credit will increase and the demand for funds is discouraged in the economy, limiting the availability of investible funds. Moreover the limited funds available will be invested in physical facilities which appreciate in value over time. Its also possible the diversion of investment portfolio into speculative activities away from directly productive ventures.
b. Other things constant, during inflation more disposable incomes will be allocated to consumption since prices will be high and real income very low. In this way, marginal propensity to save will decline culminating in inadequate saved funds. This hinders the process of capital formation and thus the economic prosperity to the country.
c. The effects of inflation on economic growth have got inconclusive evidence. Some scholars and researchers have contended that inflation leads to an expansion in economic growth while others associate inflation to economic stagnation. However, if commodity prices rise faster and earlier than will a have positive impact on economic growth. Such kind of inflation if mild, will act as an incentive to producers to expand output and if the reverse happened, there will be a fall in production resulting into stagflation i.e. a situation where there is inflation and stagnation in production activities.
d. There is always a trade-off between inflation rate and employment rate. Policy makers may undertake an inflationary measure t solve unemployment. Creating more job opportunities raises peoples’ income and their purchasing power which may eventually cause inflationary tendencies in the economy. However, if inflation reduces the level of aggregate demand to the effect of excess production capacities, unemployment will no doubt occur.
e. When inflation imply that domestic commodity prices are higher than the world market prices, a country’s exports fall while the import bill expands. This is basically due to the increased domestic demand for imports much more than the foreign demand for domestic produced goods (exports). The effect is a deficit in international trade account causing balance of payment problems for the country that suffers inflation.
f. During inflation, income distribution in a country worsens. The low income strata get more affected especially where the basic lie sustaining commodities‟ prices rise persistently. In fact such persistence accelerates the loss of purchasing power and the vicious cycle of poverty.
NB: Both fiscal and monetary policies are used to control inflation. (check)