Inflation is an economic term describing the sustained increase in prices of goods and services within a period. To some, it indicates a struggling economy, whereas others see it as an indicator of a prospering economy. Here, we examine the negative effects of inflation.
- Erosion of Purchasing Power
Inflation causes an increase in the price of general goods and services leading to a currency depreciating in value. The purchasing power of currency, and by extension savings, reduces. Inflation leads to increased consumption, which discourages savings and slows down economic growth.
2. Increases in Taxes
Higher prices lead to increases in taxes. Nominal (not real) incomes rise along with inflation and push income earners into higher percentage tax brackets. Even though purchasing power of currency does not increase, a person pays a bigger proportion of her/his income to the government. This will then lead to pay higher tax rates without an increase in real income.
3. Higher Interest Rates in the Long Run
Inflation leads to higher interest rates in the long run. When the government increases the money supply, the increased availability of money lowers interest rates. However, higher equilibrium prices and lower value of the money due to increased money supply lead banks and other financial institutions to raise rates in order to compensate for the loss of the purchasing power of their funds. Higher long-term rates discourage business borrowing, leading to lesser overall investment in capital goods and technology.
Inflation, despite its negative effects is a key part of contemporary economics. Individuals can protect their savings from inflation by investing them into commodities or other market securities like stocks and index funds.