Negative Effects of Inflation

Inflation denotes an overall increase in the prices of goods and services in an economy. In certain countries, inflation shows growth, whereas it indicates adverse economic conditions in others. The negative impacts of inflation include:

Declining purchasing power

Inflation reduces the goods or services a unit of currency can buy. For example, it cuts the items a dollar can buy from three to one. Money losses value during inflation, causing consumers to spend high amounts purchasing a single commodity.

Lower exports     

Inflation discourages countries from buying goods in a market affected by inflation. Local goods become less attractive to foreigners, causing the demand in international markets to decline. Countries importing goods from the affected nation shift to more favorable and attractive markets, lowering exports.

Reduced investments

Inflation creates confusion and uncertainty, discouraging local and foreign investors. Investors are unlikely to sign investment contracts in an economy where it is impossible to predict what might happen in the future. The adverse social and economic effects of inflation undermine economic growth, forcing investors to take investment money elsewhere.

Tax increase

The general increase in goods prices causes nominal incomes to rise, pushing wage earners into a higher tax bracket. Moving upward in the tax bracket means that an individual must remit more taxes to the government. A decline in purchasing power accompanied by an increase in taxes lowers a person’s living standards. Inflation ignites an upward trend in all taxes, including income tax and property tax. Many governments are less likely to adjust taxes with inflation rates, exposing consumers to financial hardships.

Social unrest and political instability

High inflation rates create social unrest as people pressure governments to implement policies vital in reversing or solving the inflation problem. For example, due to high inflation rates, Venezuela has experienced protests and turmoil, including an attempted assassination of the president. Growing public dissatisfaction motivates people to force the current regime to leave office and call an election to elect competent leaders. The sitting president might refuse to step down, encouraging rebels and separatist groups to take arms and fight against government forces.

Increased borrowing cost

High inflation rates are associated with an increase in the cost of borrowing funds. Governments, through central banks, adjust interest rates per the rising prices. Banks apply the new interest rates in their loans, meaning that borrowers must pay a high interest to acquire capital. An increase in the cost of borrowing discourages individuals from procuring loans, undermining investment, consumption, and economic activities.

Less saving

Inflation causes people to save less. A general rise in commodity prices entails that consumers use a large part of their income buying commodities instead of saving. Furthermore, inflation forces consumers to use savings to purchase goods, especially when wages and salaries are not adjusted to align with the inflation rates. Inflation changes people’s priorities from savings and investments to sustaining current living standards.

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