Problem

Economic inflation

Other Names:
Overheating of economy
Vulnerability of countries to inflation
Nature:

Inflation is an unacceptable decrease in the purchasing power of money, as measured by an accepted general price index. Not all increases in the general price index can be usefully labelled as inflationary, particularly when the increase over a period of months or years is relatively small. The term is usually reserved for larger increases, especially when they continue unchecked. Precise definitions are however lacking, although a general price increase of less than 1% per quarter is often considered as 'creeping' inflation. An increase of 50% per month is termed 'hyperinflation'. Although there is agreement on the general meaning of inflation, disagreement remains on how it is to be measured: which price level should be used to measure the purchasing power of money; what allowance should be made for innovations; whether both official and black market prices should be considered when the latter exist; whether prices should be gross or net of subsidies and sales taxes; and how price rises following disasters should be considered. Inflation is also a condition of generalized excess demand for stocks of goods and flows of real income, in which 'too much money chases too few goods'. It is also a rise of the money stock or money income in a society, either total or per capita. Other concepts of inflation also exist.

Incidence:

[Industrial countries] For industrialized countries as a group inflation dropped from a peak of 9.4% in 1980 to 4.8% in 1983 and declined further to 2.9% in 1987. In the developed countries represented within the OECD, whenever the general price level is rising by 5% or more, prices go up even in industries where productivity gains are well above average. Under these conditions, everyone is likely to become much more conscious of inflation. There is a general feeling of insecurity, and everyone tries to obtain priority for their income claims. An increase in inflationary expectations was clearly apparent in the acceleration in the collective bargaining cycle, the swelling demands for wage and other kinds of indexation, and the persistence of historically high interest rates. In the seventies and eighties 'double-digit' inflation appeared. Inflation feeds on itself, and unless and until people become convinced that over the longer run prices are going to be significantly more stable than they have been in the recent past, there is a clear danger that the whole process will gradually accelerate.

Contractual arrangements between borrowers and lenders, which can be modified to mitigate the adverse economic effects, pass the burden of price increases to others and make inflation increasingly difficult to control. It takes a long time before interest rates, contractual arrangements, pension schemes, etc, catch up with a given rate of inflation. The lags may be as long as 5, 10 or even 20 years, and thus there will always be distortions and inequities, the more so if the rate of inflation is accelerating. In particular, money rates of interest generally lag behind price rises thus stimulating excessive indebtedness and inefficient allocation of resources. Further, with high rates of inflation there must be much uncertainty as to what exactly the price rise is likely to be over a number of years, and this uncertainty will distort and inhibit long-run lending and investment decisions. It would therefore be quite wrong to conclude that, because the economic costs of inflation in the past have not been readily apparent, they could not quickly become considerable if the gradual but inexorable rise in inflationary expectations were to continue.

The social and political consequences of continuing inflation must also give great cause for concern. They are not easy to pin down because the impact of inflation on individuals and groups is extremely haphazard. Also, under inflationary conditions, income gains and the accumulation of wealth often appear to result not so much from work or sacrifice as from ingenuity and the exercise of economic and political power and influence. Resentment against inflation is incoherent and diffuses through the community. It therefore tends to strengthen other forces making, for disenchantment with government and existing political parties.

Counter Claim:

The desire to continue to enjoy the benefits of economic growth, coupled with the difficulty of reconciling this with reasonable price stability, raises in an acute form the question of how much inflation really matters. Post-war experience shows that some economies may learn to live with moderate inflation and that in fact rising price levels provide a stimulus to the more productive segments of the economy, spurring profits, rewarding those factors most mobile and innovative, and penalizing the lethargic non-adaptive elements. Inflation is particularly necessary in the developing countries since there is no feasible alternative for financing the investment necessary for economic growth. Inflation provoking a redistribution of income in favour of profits and economic growth is often a necessary complement in developing countries. Increases in aggregate demand must result in increased prices because of structural bottlenecks in foreign trade, transportation, materials and food.

 

Problem Type:
C: Cross-sectoral problems
Date of last update
01.11.2017 – 21:31 CET