To What Extent is Inflation a serious Economic Problem Essay

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To What Extent is Inflation a serious Economic Problem

Before considering whether Inflation has serious Economic Problems, we have to get to grasp what it exactly is. Inflation is defined as a sustained general rise in prices in the Economy. Obviously the government can't measure every single price change for every single good in the economy, so therefore they take a basket of goods and by using a price index measure a change in it. The basket of good has a representative range of goods and services and it needs to be recorded at a regular basis, to measure how inflation is changing. The UK government currently use the RPI (Retail Price Index) as a measure, which measures,
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As inflation erodes the value of cash, households are more likely to keep their money deposited in banks.
Nominal interest rates will be high as the real value of interest payments will be eroded with inflation, so banks and financial institutions will have to raise their nominal interest rates in order to try to persuade more people to keep their money deposited within banks. This means the cost of acquiring credit is higher and firms will have to cut back on investment, which slows down Growth. This time households take to find the financial institution with the largest interests also is a cost to the economy. In economic terms this is called the Shoe Leather Cost.

Another cost when inflation is high is called the Redistributional
Cost. This merely means that inflation can redistribute income and wealth between households, firms and the state. For instance, a fixed income receiver will suffer, if inflation increases. Pensioners on fixed private pensions will lose real income in inflation doubles and their pension stays the same. The value of the money they have received has decreased. Also if real interest rates fall, due to inflation there will be a transfer of resources from borrowers to lenders. The saver will lose the real value lf savings each year, whilst a borrower will see a real reduction in the amount of dept owed per annum.

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