Inflation is an economic phenomenon that describes the general increase in the prices of goods and services in the economy. So inflation is the rate at which the average prices of certain selected goods increase in a given time period.
So inflation also indicates the loss of purchasing power of the consumer. The same unit of currency will buy fewer goods and services as their prices increase. This is the loss of purchasing power of the currency of a country.
EFFECTS OF INFLATION
Persistent inflation in an economy can have some very adverse effects. Many problems currently plaguing our economy are results of inflation in our economy. Rapid inflation can disrupt our entire economy can cause a financial crisis in the country. Let us take a look at some of the adverse effects that are results of inflation in the Indian Economy.
Balance of Payments
India’s current account deficit is around 17 billion dollars for the last quarter of 2018. This is roughly 2.5% of our GDP. This is because for years now India’s imports are mismatched with their exports. With increasing prices of goods in India, exports have seen a further decline. And the imports have actually become cheaper. So the current account deficit will continue to be a problem for our economy.
Industrial Sector
India has seen a stagnation in the industrial growth in the last few years. The industrial growth for the month of February 2019 year-on-year was merely 0.1%. This is because inflation has adversely affected the industrial sector as well.
The rising prices mean that the factors of production like labor and raw materials have also become expensive. The profit margins of the companies are decreasing. And after an extent, the companies pass on the burden of these additional expenses to the final consumer. And the entire economy suffers.
Banks will increase interest rates as inflation increases otherwise real interest rate will be negative. (Real interest =
Nominal interest rate – inflation). This makes borrowing costly for both consumers and corporate. Thus people will
buy fewer automobiles, houses and other goods. Industries will not borrow money from banks to invest in capacity
expansion because borrowing rates are high.
Higher interest rates lead to slowdown in the economy. This leads to increase in unemployment because companies
start focusing on cost cutting and reduces hiring. Remember Jet Airways lay off over 1000 employees to save cost.
Rising inflation can prompt trade unions to demand higher wages, to keep up with consumer prices. Rising wages
in turn can help fuel inflation.
Inflation affects the productivity of companies. They add inefficiencies in the market, and make it difficult for
companies to budget or plan long-term. Inflation can act as a drag on productivity as companies are forced to shift
resources away from products and services in order to focus on profit and losses from currency inflation.
Final Consumer
The person most affected by rising inflation is the final consumer of goods. The prices of goods and services are constantly rising. But the salaries and income of consumer do not rise proportionately, there is a lag. So the goods and services become less affordable to these final consumers. And the population in the lowest income group are the most affected. They cannot even afford basic necessities.
Investments
One of the major results of inflation in an economy is the general slowdown of the economy. When this happens unemployment rates rise, the purchasing power of the consumer decreases, credit becomes expensive. All these cause a strain on the entire financial system of the country. It discourages heavy investment in the economy by both domestic and international players.
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