Effects of Inflation. Academic PowerPoint. Copyright - Kramzil Pty Ltd trading as Academic Teacher Resources

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1 Academic PowerPoint Copyright - Kramzil Pty Ltd trading as Academic Teacher Resources 1

2 Impact on Output - In general inflation has major costs for the economy, the producer and the consumer. 2

3 Inflation causes productive investment to fall because profitability falls, speculative investment rises which has a negative effect on employment, output and income. Inflation causes resources to be misallocated. 3

4 Inflation causes uncertainty to increase which can erode business and consumer confidence. The drop in confidence can reduce investment and consumption which produce downward pressure on employment and production. 4

5 Inflation leads to domestic interest rates increasing. Like other prices, the price of money rises to compensate suppliers of money (lenders/savers) for the falling value of the dollars they are repaid. This reduces investment and consumption leading to negative effects on employment and output. 5

6 If Australia s inflation rate is greater than overseas inflation rates, exports decrease and imports increase. This reduces output and employment. Australia also becomes less internationally competitive, the Current Account deficit also rises. 6

7 Government may tighten fiscal and monetary policies to reduce inflation, thus causing unemployment to rise and production to decrease. 7

8 Inflation causes a redistribution and reallocation of resources to the following groups: Speculators Borrowers/Lenders Strong Employee Groups in Key Industry Monopolies / Oligopolies in Key Industries Government 8

9 Speculators: buy and sell property, collectables (eg: art precious metals) etc. during inflationary periods because these items rise faster in price than the general price level which results in Speculator s real income increasing. 9

10 Borrowers/Lenders - (depending on interest rates): borrowers benefit if the inflation rate is greater than the interest rates. They pay back dollars of less value and lenders lose. 10

11 Strong Employee Groups in Key Industries: can use industrial muscle to gain wage/fee increases greater than other groups of employees and the inflation rate ( distributive affect). 11

12 Monopolies / Oligopolies in Key Industries: can raise their prices ahead of inflation and / or pass on cost increases to consumers to maintain or raise profits (distributive effects). 12

13 Government: revenue rises due to bracket creep, ie: inflation lifts people into higher income and marginal tax brackets, where they pay a higher proportion of income tax to the government. 13

14 Inflation causes a redistribution and reallocation of resources away from the following groups: Fixed Income Earners Weak Union or Non-union Sections of the Workforce Borrowers/Lenders Firms in Highly Competitive or Depressed Industries Savers 14

15 Fixed Income Earners: real incomes decrease as changes to money incomes lag well behind inflation eg: the unemployed, public servants etc. 15

16 Weak Unions or Nonunionised Sections of the Workforce: their money incomes fall behind inflation because they lack industrial muscle. 16

17 Borrowers/Lenders (depending on interest rates): borrowers lose if interest rates move ahead of inflation. Lenders anticipate inflation and raise rates to protect real returns. 17

18 Firms in Highly Competitive or Depressed Industries: rising costs reduce profits when firms cannot easily raise prices. 18

19 Savers: savings in conventional low interest bank deposits lose value. 19

20 Conclusion: Inflation transfers income between competing income groups. It causes a redistribution of income away from weaker, low income earners to more protected high earners in both private and public sectors. 20