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Why is inflation a bad thing?

Basically, I gotta write 1 side discussing why inflation is bad. I have some ideas but am struggling to find any real reasons which I can elaborate on to in effect write an essay on this topic. I'm doing unit 2 as economics and my teacher hasn't fully taught this yet and wanted us to do this to help develope our own knowledge of inflation.

I'm not after a full write up and know you won't give me one but could u please give me some ideas or leads so I can formulate this myself

many thanks lee

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Reply 1
It isnt necessarily providing it is sustainable. Primarily inflation is considered bad because it is a persistant rise in the price level of an economy. This rise may lead to distortions within the economy with a series of negatives effects:

-It erodes the value of cash hence if you have a pound today and prices rise 5% tomorrow it will now effectively only be worth 95p

-Those who invest for a fixed return or those on fixed incomes (specifically pensioners), for the reasons named above, will find they have a drop in purchasing power and are thus less well off because of it

-The rise in price for a specific good would normally suggest an increase in demand sending confusing signals to producers leading to inefficient allocation of resources.

-Persistantly high inflation also serves to destabilise an economy. Inflation will cause a cry for higher wages which perpetuates higher inflation etc etc untill something gives and the economy overheats. It lowers confidence in the economy which may see investment from overseas or even domestically slow down curtailing growth or even leading to a recession.

for AS im sure this is more then enough! add a bit more meat to the bones and you have your side of A4.

BTW im pretty sure a google search would yield this kind of analysis - probably better tbh, get used to researching stuff your self its a good skill to have!
If you want to really impress your teacher and gain lots of evaluation marks. Do a paragraph on inflation not being bad at, say that when wages rise with inflation even though wages dont go up in real terms but in nominal terms workers still feel more wealthier and are more inclined to spend.
Reply 4
lee_91
Basically, I gotta write 1 side discussing why inflation is bad. I have some ideas but am struggling to find any real reasons which I can elaborate on to in effect write an essay on this topic. I'm doing unit 2 as economics and my teacher hasn't fully taught this yet and wanted us to do this to help develope our own knowledge of inflation.

I'm not after a full write up and know you won't give me one but could u please give me some ideas or leads so I can formulate this myself

many thanks lee




well im an as student, so my ideas may not be very good...but if the price level of goods are rising, especially higher then the rate wages are rising, people wont be able to afford as many goods/services and this will lead to cyclical unemployment (less aggregate demand - lay off workers) govn then have to increase spending on social security and benefits (leads to opp cost) and the the cost of unemployement are... and so on hope thats helpful
Reply 5
thanks for your input all, very helpful,

lee
Include a paragraph saying a low and stable rate of inflation is good for the economy while no inflation is bad as well
other points to mention

- "menu costs", put crudely you were a restaurant, and your prices went up every week, you'd have to keep reprinting your menu, so there's a nuisance and cost in time and money of constantly having to update your price listings. If you were a business that kept finding out all its advertising and promotional materials were out of date and had to keep reprinting them every month or so to reflect price changes, then thats an extra cost you could do without

- uncertainty - firms rely on future financial planning to make investment decisions, if you're going to open a new plant in a new place, what are your costs going to be a year from now, what will your income be a year from now etc. If inflation is high then it makes it harder to guess what the actual costs will be, so firms tend not to make any investment decisions until inflation settles down. If nobody invests then the economy stands still.

- spoils our credibility with international investors - they don't like the idea that any debts the UK owes to international investors are getting the real value eroded away by us allowing inflation to run riot. Whilst we might be able to scam off our former creditors this way, future investors will see us as a bad bet.
Another few points to add to the above:

Shoe Leather Costs: As inflation decreases the real value of cash, it means that people keep less cash on them. This results in more time spent walking to the banks/ATMs to withdraw money. This is an opportunity cost of wasted time.

If it is due to cost-push inflation, then it can kick off a price-wage spiral, where workers ask for higher wages to keep their real wages the same. These higher wages lead to further inflation, and so on.

Inflation hurts savers, as their savings depreciate in their real value. Conversely, it helps borrowers, so anyone in debt (note: government) benefits from inflation, as the real value of their debt depreciates.

If there is high inflation then hoarding can occur, this is when people buy durables as a means of keeping wealth (as currency is depreciating in real value). This can lead to shortages.

In times of high inflation, the price signal is lost, this means that there can be a loss of allocative efficiency as producers cannot respond to the signal of falling/rising prices as efficiently. Gluts and shortages of products can occur.

One positive point to note is that a stable rate of inflation can increase investment, leading to faster growth. This is because it disincentives those businesses from holding cash relative to investing in capital goods. Thus, to avoid inflation, businesses will increase their stock of capital.
Reply 9
yoyo462001
If you want to really impress your teacher and gain lots of evaluation marks. Do a paragraph on inflation not being bad at, say that when wages rise with inflation even though wages dont go up in real terms but in nominal terms workers still feel more wealthier and are more inclined to spend.


doesnt this assume thought that people dont know what the real wage is?

i.e. imperfect information model of the business cycle?
if you need a case study: http://en.wikipedia.org/wiki/Hyperinflation_in_Zimbabwe

People were having to spend their money the day they earnt it
Reply 11
danny111
doesnt this assume thought that people dont know what the real wage is?

i.e. imperfect information model of the business cycle?


yes it does, working along the lines of the freidman lucas money suprise model... where people see a nominal rise and mistake it for a real rise. This is due to a lack of information but lets face it even with all todays price indices etc there will still be many out there who are unaware if the rise has been real or nominal.
danny111
doesnt this assume thought that people dont know what the real wage is?

i.e. imperfect information model of the business cycle?

Yea pretty much however i would argue that even under the assumption of perfect knowledge, even if people know they're wages haven't gone up in real terms they do still tend feel wealthier.
Reply 13
yoyo462001
Yea pretty much however i would argue that even under the assumption of perfect knowledge, even if people know they're wages haven't gone up in real terms they do still tend feel wealthier.


not if they are rational.
Reply 14
DaddyT
yes it does, working along the lines of the freidman lucas money suprise model... where people see a nominal rise and mistake it for a real rise. This is due to a lack of information but lets face it even with all todays price indices etc there will still be many out there who are unaware if the rise has been real or nominal.


I agree!

But thats why we have the model. You need to state your assumptions (and say what model you are using). And to be honest, I dont think at A level one needs to discuss this. Especially because the mark schemes are like the holy grail so you would want to stick to it, unless of course they allow for the student to interpret the question in his own way and make an argument not necessarily given in the syllabus. I guess thats why I did not like school economics.


Are you at university btw?
Reply 15
It's simple really, if inflation occurs then prices rise which will affect consumer spending habits, Consumers will not spend more of their cash because the high prices doesn't attract them to the products. Also, if inflation occurs, then interest rates will rise and so business will not borrow money to expand nor will consumers borrow more moeny to spend. Less spending means the Government is not getting more money. If businesses cannot sell their products, they will start to make a loss and to cover this loss, they will probalbly make employees redundant and so unmeployment in the economy will rise which again the Government will get less money becasue less people are working and they will have to pay unemployment benefits. However, inflation can be a positive thing to the economy because then foreign people will be attracted to save in the economy because if you save when interest rates are high, then you will get more value for your money.

It's simple GCSE economics
Reply 16
everything becomes expensive
Reply 17
Oasis Jnr
It's simple really, if inflation occurs then prices rise which will affect consumer spending habits, Consumers will not spend more of their cash because the high prices doesn't attract them to the products. Also, if inflation occurs, then interest rates will rise and so business will not borrow money to expand nor will consumers borrow more moeny to spend. Less spending means the Government is not getting more money. If businesses cannot sell their products, they will start to make a loss and to cover this loss, they will probalbly make employees redundant and so unmeployment in the economy will rise which again the Government will get less money becasue less people are working and they will have to pay unemployment benefits. However, inflation can be a positive thing to the economy because then foreign people will be attracted to save in the economy because if you save when interest rates are high, then you will get more value for your money.

It's simple GCSE economics


be careful not to confuse cause and correlation in economics.

inflation is not necessarily a cause of higher interest rates.

in fact in the Keynesian Model with investment shocks, the model predicts that central bank can utilise stabilisation policy by increasing the money supply. with the outcome that the interest rate falls but prices rise.
Reply 18
danny111
I agree!

But thats why we have the model. You need to state your assumptions (and say what model you are using). And to be honest, I dont think at A level one needs to discuss this. Especially because the mark schemes are like the holy grail so you would want to stick to it, unless of course they allow for the student to interpret the question in his own way and make an argument not necessarily given in the syllabus. I guess thats why I did not like school economics.


Are you at university btw?


I agree with you on this which is why i didn't suggest him to really go into it, at anything below degree level its essential you tick the correct boxes rather then demonstrate a wider understanding...saying that even at degree level that is sometimes the case.

o dear have my posts been that bad that you need to ask if i'm at university lol. Yes i'm a finalist...role on june!
Oasis Jnr
It's simple really, if inflation occurs then prices rise which will affect consumer spending habits, Consumers will not spend more of their cash because the high prices doesn't attract them to the products. Also, if inflation occurs, then interest rates will rise and so business will not borrow money to expand nor will consumers borrow more moeny to spend. Less spending means the Government is not getting more money. If businesses cannot sell their products, they will start to make a loss and to cover this loss, they will probalbly make employees redundant and so unmeployment in the economy will rise which again the Government will get less money becasue less people are working and they will have to pay unemployment benefits. However, inflation can be a positive thing to the economy because then foreign people will be attracted to save in the economy because if you save when interest rates are high, then you will get more value for your money.

It's simple GCSE economics

Uhhh, that is a lovely collection of bad economics right there. If inflation occurs consumers will spend more, as durable goods are a better store of wealth than currency, as the real value of currency is falling due to inflation.

Inflation helps those who have already borrowed as the real value of their debt is falling. The nominal interest rate may rise, but only so that the real interest rates stay the same. This means there will be no effect on business investment/consumer borrowing due to no change in real interest rates. It has been noted than moderate inflation can increase business investment, as physical capital becomes a more attractive prospect relative to currency, as currency is continuously depreciating.

Government benefits from inflation - as it is a debtor at long-term fixed interest rates. High inflation means that the real value of public debt falls.

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