Inflation Case Essay Sample

Inflation Case Pages
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Inflation is defined as a steady rise in the general price level, which is an average of the prices of all goods and services available in a specified economy (Henderson & Poole, 1991). A high rate of inflation is bad for the economy because of several reasons. First, a high rate of inflation is invariably associated with significant redistribution of wealth. If it occurs unexpectedly, the high inflation rate can cause borrowers to gain at the expense of creditors as the former pay back the borrowed amounts in less valuable currencies. Whereas such redistributions are not associated with wealth destruction, they are bad for the economy as they cause the distortion of incentives. This situation was witnessed during the great German inflation where borrowers made massive gains while lenders suffered great losses (Henderson & Poole, 1991).

Secondly, a high rate of inflation is associated with efficiency losses on the economy. In addition, a high rate of inflation is associated with high levels of unemployment (Krugman, 1999). This relationship is illustrated by the Phillips curve below. As the rate of inflation rises, the unemployment level increases.

Source: Henderson & Poole (1991)

Inflation is also bad for the economy because it distorts the tax system.  This occurs when individuals are thrust into higher tax brackets as a result of higher incomes occasioned by inflation. Since it interferes with the motivation which the tax system gives to people in order to encourage them to work, save and invest, inflation impacts negatively on economic activities. Besides, a high rate of inflation can lead to high nominal interest rates. Finally, inflation is bad for the economy because it hinders long-term planning (Henderson & Poole, 1991).

References

Krugman, P. (1999). The Return of Depression Economics. Allen Lane the Penguin

            Press,   U.K.

Poole, W & Henderson, V. J. (1991). Principles of Macroeconomics. U.S.A: D.C.

            Heath and Company, Lexington, pp.714

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