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Is Inflation Harmful?
By: Richard PEttinger
The Govt set the MPC a target for CPI of 2% +/-1 therefore it believes inflation
higher than 3% is potentially damaging for the economy.
1. It depends on inflation in other countries. If inflation in the UK is higher
than elsewhere then UK goods will become uncompetitive leading to a fall in
demand for UK exports.
If there is a fall in demand for Exports then there may be a deficit on the
current account Balance of Payments. However this may be offset by a devaluation
that is likely to occur.
2. However if inflation is high there will be a devaluation of the exchange
rate, This is something the govt wishes to avoid as it creates uncertainty
amongst business.
3. Higher rates of inflation may cause menu costs, which means firms have to
change price lists quite often. However this is not that significant when
inflation is only 5%.
4. If inflation is caused by unsustainable economic growth then the boom may be
followed by a recession . To keep inflation within target the Bof E will have to
increase interest rates, this causes problems because AD will fall causing lower
growth.
5. Higher rates of inflation are disliked by business because it makes it more
difficult to predict future costs. Therefore investment will be lower, Countries
with lower inflation rates generally have poorer economic growth.
6. A high rate of inflation would make it more difficult to join the EURO,
because it would breach the Maastricht criteria. If inflation in the UK was
higher than Europe a single Monetary policy would be ineffective for the UK.
7. If the inflation was world wide caused by an increase in the oil price, it
may be necessary to revise the inflation target of 2.5% . The UK would not lose
its competitive advantage because every country would have higher inflation. TO
reduce inflation would cause stagflation (lower growth and lower prices)
8. Inflation may cause redistribution of income from savers to borrowers,
although this will depend upon the rate of interest. E.g. if interest rate were
8% savers would still have a real interest rate of 3%
9. It depends on whether wages are keeping up with inflation. If wages were only
increasing by 4% then real wages would be falling.
Should the govt be concerned with inflation falling below 2%?
1. If prices are falling because AS shifts to the right because of new
technology, this is beneficial for the economy, because growth is increasing and
jobs being created.
2. If deflation is cause by falling AD then this is serious economic problem
because it indicates a recession with problems such as unemployment, lower
output and a negative multiplier effect
3. Deflation can cause problems for the economy. It means that those who have
debts will see the real value of debts increase, this will lead to lower
consumer confidence and possibly lower AD and economic growth.
4. Deflation makes monetary policy ineffective. This is because interest rates
cannot be reduced below 0%.
5. Companies cannot alter real wages easily because workers are very resistant
to any cut in nominal wage wages.
6. It is more difficult to set prices when there is deflation
Conclusion.
Moderate inflation is not a problem, but if inflation is very high it creates
instability and uncertainty in the economy. However just as damaging as
inflation is deflation
About the Author:
Richard studied Economics and Politics at Lady Margaret Hall, Oxford. He is a
student of Sri Chinmoy and gives meditation classes for the Sri Chinmoy centre.
He edits a website called: http://www.srichinmoysongs.com/
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