10 Pros and Cons of Inflation | UPSC

10 Pros and Cons of Inflation | UPSC

      HEADLINES:

Why containing inflation, instead of boosting growth, could be the bigger challenge for policymakers in 2021

      WHY IN NEWS:

Once this trend takes hold, as it did in 2011, it remains elevated for a prolonged period.

SYLLABUS COVERED: GS 3: Economy : Inflation

      ISSUE: 

India has had trouble in the past with rising prices of services.

ON THE PATH OF RECOVERY 

  • While much of the fiscal support packages around the world have been directed towards safeguarding the vulnerable; there were some misses, such as the urban poor being left out.
  • Over the past few weeks, India seems to have broken the link between rising levels of mobility and COVID-19 cases.
  • In fact, the number of new cases has fallen while the fatality rate continues to drop.
  • The last quarter saw an improvement in growth as consumers were eager to spend, especially on festival-related items, bolstered by higher-than-usual financial savings.

Once this trend takes hold, as it did in 2011, it remains elevated for a prolonged period. And trying to boost supply takes time 

INFLATION 

  • Inflation, in the basic sense, is a rise in price levels.
  • Economists believe inflation comes about when the supply of money is greater than the demand for money.
  • Inflation is viewed as a positive when it helps boost consumer demand and consumption, driving economic growth.

ADVANTAGES OF INFLATION

  • Deflation is potentially very damaging to the economy and can lead to lower consumer spending and lower growth.

EXAMPLE
When prices are falling, consumers are encouraged to delay purchasing in the hope prices will be cheaper in the future.

  • A moderate inflation rate reduces the real value of debt.
  • If there is deflation, the real value of debt increases leading to a squeeze on disposable incomes.
  • Moderate rates of inflation allow prices to adjust and goods to attain their real price.
  • Moderate rates of wage inflation, allow relative wages to adjust.

Nominal wages are sticky downwards. With moderate inflation, firms can freeze pay rises for less productive workers – to effectively give them a real pay cut 

  • Moderate rates of inflation are a sign of a healthy economy. With economic growth, we usually get a degree of inflation.

DISADVANTAGES OF INFLATION

  • High inflation rates tend to cause uncertainty and confusion leading to less investment.
  • It is argued that countries with persistently higher inflation, tend to have lower rates of investment and economic growth.
  • Higher inflation leads to lower international competitiveness, leading to fewer exports and a deterioration in the current account balance of payments.
  • Inflation and stagnant wage growth lead to declining incomes.

Inflation can reduce the real value of savings, which might particularly affect old people who live on savings 

  • Inflation will reduce the real value of government bonds.
  • Investors will demand higher bond yields to compensate; this will increase the cost of debt interest payments.
  • Hyper-inflation can destroy an economy.
  • If inflation gets out of hand, it can create a vicious cycle, where rising inflation, causes higher inflation expectations, which in turn pushes prices even higher.
  • Hyper-inflation can wipe out the savings of the middle-classes, and redistribute wealth and income towards those with debt and assets and property.

 Then there is the rise in inequality between large and small firms, which is likely to be felt by individual employees

  • For individual, all this could impact demand over time.
  • A deeper look suggests that the low level of fiscal spending could leave behind other problems, such as rising inequality and inflation.It could stoke inflation.
  • India has had trouble in the past with rising prices of services.

      IASbhai WINDUP: 

  • To restore price stability, Governments/Central Banks need to pursue deflationary fiscal/monetary policy

However, this leads to lower aggregate demand and often a recession 

  • The cost of reducing inflation – is unemployment, at least in the short-term.
     SOURCES:    IE  | 10 Pros and Cons of Inflation | UPSC

 

DISCOVER MORE : GENERAL STUDIES-III

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