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Home Field Trips Copper Tour The Problems Associated with Inflation

Theories

The Problems Associated with Inflation

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There are a number of ways in which high rates of inflation impact on the lives of those people living and working in LDCs such as Zambia.

• Rising prices causes worsening poverty as the essentials for survival become more expensive and thus less attainable to those with low incomes. In an economy where unemployment and underemployment is increasing, family incomes are less able to purchase the basic requirements such as staple foodstuffs.
• Rising prices creates uncertainty. In a climate of uncertainty both domestic and foreign entrepreneurs will be reluctant to invest. This will slow down the potential for economic growth.
• Low savings is a factor contributing to the cycle of poverty. During periods of inflation households that do have surplus funds are reluctant to save. Inflation erodes the real value of saving and hence there is less incentive to forego current consumption. Decreasing levels of savings and hence of investment will lead to a decline in economic growth and development.
• Inflation will lead to increases in nominal interest rates. The real value of interest payments will be eroded with inflation and thus banks and financial institutions will have to raise their nominal interest rates in order to try to persuade people to keep their money deposited with banks. Increases in interest rates will make the cost of acquiring credit higher. This will cause firms to cut back on investment.
• Inflation in Zambia will make Zambian exports more expensive and less competitive in regional and world markets. This will worsen the balance of payments situation and increase their debt and dependency on donor countries.
• Many of the problems connected with inflation depend upon the extent to which the inflation is anticipated correctly or not. If it is unanticipated or not anticipated correctly there may be certain distributional effects. This means that there may be some gainers and some losers. Often it is low paid fixed income workers who loose out whilst those people whose incomes are dependent upon profits who gain. Workers in state owned enterprises often loose out if the government is being pressurised to cut back on government spending whilst those workers in private sector firms may see their wages increase as sales increase.

Benefits of Inflation: Is it always bad?

• Low levels of inflation will often result in firms experiencing increases in profitability. This will provide funds for investment purposes.
• Inflation will erode the real value of loans that have been taken out and therefore may make repayment of existing loans easier.

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Related Glossary Items:
Demand Pull Inflation
Cost Push Inflation
Inflation
Investment
Economic Growth
Monetarists

Related Issues:
The Impact of Inflation on Zambia

Related Theories:
The Causes of Inflation