Main Costs of Inflation
Impact of Inflation on Savers:
Inflation results in money losing its value – you can’t buy as much with £100 today as
you could with £100 100 years ago because of the effect of inflation.
Inflation then encourages spending not saving.
Inflation Expectations and Wage Demands
Inflation can get out of control because price increases lead to higher wage demands as
people try to maintain their real living standards.
Businesses then increase prices to maintain profits and higher prices then put further
pressure on wages.
This process is known as a ‘wage-price spiral’. Rising inflation leads to a build-up of
inflation expectations that can worsen the trade-off between unemployment and inflation
(see Phillips Curve)
Re-Distributions of Income
Inflation tends to hurt those on fixed incomes e.g. pensioners and those who work in jobs
where they have poor bargaining positions.
Business Planning and Investment
Inflation harms business planning. Budgeting becomes difficult because of the uncertainty
created by rising inflation of both prices and costs - and this may reduce planned capital
Lower investment then has a detrimental effect on the economy’s long run growth
Competitiveness and Unemployment
Inflation is a possible cause of higher unemployment in the medium term if one country
experiences a much higher rate of inflation than another, leading to a loss of
international competitiveness and a subsequent worsening of their trade
Both trends could lead to a worsening balance of payments.
The Government believes that monetary stability (i.e. low inflation) is a precondition for
sustained economic expansion.