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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 investment spending. Lower investment then has a detrimental effect on the economy’s long run growth potential 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 performance. 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. |