Discuss in detail the consequences of inflation (Inflation). Inflation is an increase in the prices of goods and services. The most well-known indicator of inflation is the Consumer Price Index (CPI), which measures the percentage change in the price of a basket of goods and services consumed by households (see Explainer: Inflation and its Measurement).
Discuss in detail the consequences of inflation (Inflation)
INTRODUCTION
- This is a constant and significant increase in the general price level of goods and services in the country over a certain period of time, e.g. a year. 🗸🗸
[Max 2]
[Accept any relevant introduction]
BODY-MAIN PART
Creditors and Debtors
- Whereas borrowers (debtors) benefit from price increases, lenders (creditors) suffer due to price increases. 🗸🗸
- This is because borrowers receive money with a relatively high purchasing power and they repay their loans with money with low purchasing power, unless interest rates are sufficient to prevent this occurrence. 🗸🗸
Salary and Wage Earners
- Price increases affect people whose incomes are relatively fixed (in other words, people whose incomes remains constant or do not increase at the same rate as prices do. 🗸🗸
- This group includes retired people, pensioners and the poor. 🗸🗸
- As prices increase, their almost fixed incomes purchase less and less. 🗸🗸
- However there are individuals and entrepreneurs whose incomes often increase at a rate that is higher than the inflation rate and they do not suffer but gain from inflation. 🗸🗸
- Globalization results in increased employment opportunities in the economy due to increased productivity, the need to produce more goods both for local and international markets rises in globalised economies. 🗸🗸
- The demand for increased skilled labour becomes a need as a result, this demand for labour benefits the local labour market in increased employment opportunities and growth. 🗸🗸
Investors and Savers
- Different types of investments are affected by inflation: Assets with fixed nominal values. 🗸🗸
- These assets have a fixed nominal value and give a return if they are held until maturity. 🗸🗸
- When they are paid, because their nominal values remain constant, the purchasing power of the nominal values decreases as prices increase (that is, their real value decreases). 🗸🗸
Assets with Flexible Market Values
- The holders of shares and fixed property usually gain by price increases because the nominal values of these assets tend to increase at least proportionately to the rate of inflation (that is, their market values are flexible). 🗸🗸
- Often the prices of these assets increase more rapidly than increases in the general price level.🗸🗸
- In this case, inflation creates wealth to the advantage of those holding such assets. 🗸🗸
Tax Payers
- South Africa has a progressive personal income tax system. 🗸🗸
- This means that marginal and average tax rates increase in harmony with the income level. 🗸🗸
- The higher level an individual’s income, the greater the percentage of income he or she has to pay tax. 🗸🗸
- With inflation, taxpayers’ nominal income (wages and salaries) rise even when their real income remain unchanged. 🗸🗸
Taxes are levied on nominal income and not on real income.
- Therefore if the income tax schedule remains unchanged inflation increases the average rate of personal income tax. 🗸🗸
- Individuals will have to pay higher taxes even if they are actually no better off than before. 🗸🗸
- This phenomenon known as bracket creep, lads to a redistribution of income from taxpayers to the government. 🗸🗸
- Bracket deep results from a combination of inflation and progressive income tax. 🗸🗸
- It has the same effect as an increase in the tax rate. 🗸🗸
Industrial Peace
- Wage bargaining is often accompanied by strikes and mass action. 🗸🗸
- These actions can sometimes spill over into violence, which affects society at large. 🗸🗸
- In extreme situations in the presence of exceptionally high inflation together with a government that is determined not to yield to wage increase demands (which can push inflation to even higher levels), widespread civil unrest follows. 🗸🗸
Inflation has a negative effect on economic growth
- Inflation leads to increased uncertainty in the economy. 🗸🗸
- This uncertainty discourages savings and investments especially in the long term. 🗸🗸
- Which are necessary for economic growth –result reduced economic growth. 🗸🗸
Inflation affects the real money value and savings
- Because inflation reduces the real value of money, it affects the real value of money saved in particular. 🗸🗸
- This means that inflation, the rand buys fewer goods and services than before. 🗸🗸
- It also means that the real money value saved is worth less at the end of the savings period than when the money was saved. 🗸🗸
- e.g. if a consumer receives 5 % interest on his/her savings account while the inflation rate is 8%, then the real rate of interest on the consumer’s savings is -3%.🗸🗸
Inflation has an adverse effect on a country’s balance of payments (BOP).
- If a country’s rate of inflation is higher than that of its trading partners the prices of exported goods increase while the prices of imported goods decrease. 🗸🗸
- This leads to loss of competitiveness in the export market, which in turn leads to decreased exports. 🗸🗸
This has a negative effect on the country’s balance of payments (BOP).
- The loss of export competiveness can also increase unemployment inflation affects the redistribution of income in a country. 🗸🗸
The effects of inflation are uneven.
- While it does not clearly benefit anyone and certainly harms most, it also harms some less than others. 🗸🗸
- Inflation also tends to redistribute income from low-income groups to higher income groups. 🗸🗸
- This is because people in the low income groups do not have assets than can rise in value faster than the rate of inflation to help them overcome the effects of inflation. 🗸🗸
- Powerful groups such as trade unions large companies and the wealthy people, are able to increase their share of national income at the expense of disadvantaged people such as pensioners the unemployed and the welfare recipients. 🗸🗸
Inflation has social and political costs
- When inflation continually causes rising prices it makes people unhappy and can disturb relations between employers and the employees and between customers and traders or service providers. 🗸🗸
- People in lower-income brackets feel severe effects of increases in the price of essential items such as bread, maize meal rental and transport costs. 🗸🗸
- This can lead to social unrest and political unrest. 🗸🗸
Inflation feeds on itself and causes further inflation
- This is called the inflation spiral. 🗸🗸 e.g. higher wage demands cause producers to increase their prices to maintain their profits.
- This happens again and again pushing prices further every time. 🗸🗸
- If the government does not keep this wage price spiral in check, inflation may get out of control and become hyperinflation. 🗸🗸
[Max 26]
ADDITIONAL PART
Debate the merits (benefits) of administered prices by the government
- These are prices regulated by the government e.g. home owner’s costs on water/household fuel (paraffin and electricity) medical care (public hospitals) communication (telephone calls, telephone rentals and installations/postage cell communications /transport (petrol). 🗸🗸
- Most of the administered prices are adjusted once a year which brings price stability. 🗸🗸
- Regulated prices are restricted as to the extent to which prices may vary, depending on the government’s objectives. 🗸🗸
- Administered prices provide additional revenue to national treasury. 🗸🗸
- It appears that some of these prices remain extremely robust over the short term. 🗸🗸
[Accept any other relevant response]
[Max 10]
CONCLUSION
- If inflation is not controlled by the proper and effective instruments, it can have challenging problems to the economy in general. 🗸🗸