Inflation is the prolonged increase in the prices of goods and services in a country. Inflation is a result of a rising money supply in the economy. That is the money in the hands of the consumers is more causing an increase in the aggregate demand. The increasing demand has an effect of increasing commodity prices which if not controlled in time, continue to rise causing inflation. Inflation is determined by the use of the consumer price index (CPI) which is the purchasing power of money.
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Inflation is an advantage both to the consumers and the government. Firstly inflation brings business growth. People will buy now to avoid an increase in the pieces in the future. The current high purchase of the money held by the consumers will make the business to grow and promote new investments.
Inflation is useful for money borrowers. Somebody borrowing money today will not pay in the future the same value of the money borrowed. Because of a decrease in the money value, the borrower pays less. For example one dollar today will not hold the same value tomorrow. On the other side, the lender of the money loses some value of the money given in the past. Therefore inflation helps in the redistribution of income between the creditors and the sellers.
Inflation improves on the business’s financial stability. The company assets increase in the values due to inflation. The financial sector also benefits through the security brought by debtors when taking loans. In case there the loan is not paid by the debtor, the financial institutions gain more through the appreciated security. Inflation will increase the value of the loan security. Low inflation is useful in reducing the economic recessions therefore favoring the labor market (Mankiw, 2009:189).
Deflation is a continuous increase in money value. The purchasing power of money increases over time therefore consumers can get more commodities than in the past for the same amount of money. In a deflationary economy, people tend to save more now and consume in the future.
Deflation results in less spending by the consumer. The little spending reduces the demand for commodities thereby the businesses reduce their production. Also, the expectation of money increase in the future makes the consumer hold back their money for future spending, thereby reducing the aggregate demand in the country.
Deflation increases the future monetary value, therefore the cost of borrowing money increases in the real value in the future. Borrowers suffer by paying more than they borrowed. This lowers the consumers’ attitude toward borrowing thereby reducing the aggregate demand of the country. The reduced demand negatively affects economic growth. High real interest rates increase the cost of repaying borrowed money also interest rates make the consumer decrease the spending (Baumol and Blinder, 2007).
Financial systems may become unstable due to the high debt cost which may make some debtors default loan. The loan cost may seem to be high because of the reduced value of collaterals.
Deflation affects the number of profits the businesses make. This is because of the reduced demand for commodities which also reduces production. Lower production leads to reduced profits that result in low investment and later high unemployment (Tanaka, 2004:418).
Baumol W. and Blinder A S. (2007). Macroeconomics: principles and policy. London: Macmillan publishers.
Mankiw, G. (2009). Principals of economics.USA: Lachina publishers.
Tanaka, G. (2004). Digital deflation: The productivity revolution and how it will work. New York: McGraw hill publishers.