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Significance of Inflation to Corporate Finance Essay (Article)

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Updated: Mar 16th, 2022

Overview

In the aftermath of the recent global financial crisis, several arguments have been brought forward regarding which is better between high and low inflation rates. From the onset, high inflation rates erode the purchasing power or capability of consumers and at the same time result in economic instability for governments, institutions, and individuals (Taylor, 2008, p. 11). On the other hand, proponents of elevated inflation rates argue that in conditions of low inflation, financial institutions like banks find it hard to adjust to changes that occur abruptly. The argument goes on that with elevated inflation rates, there is always a chance to cut down on interest rates as compared to instances when the inflation rates are low and interest rates need to be downsized (Hilsenrath, 2010, p. 1). There is also another argument for high inflation in the sense that debtors to financial institutions will in turn raise their incomes and thus find it easier to clear their loans. However, a critical look at these arguments shows that low inflation rates augur well with humanity than otherwise.

Analysis

Unrelenting high inflation rates place the economic stability of nations, institutions, and indeed individuals on a knife-edge. Purchasing ability is reduced with high inflation, leading to increased costs of living for the ordinary citizen. Consequences of elevated levels of inflation do not normally get equally felt across the financial system. This means that there is a group of people who are shielded from the impact while others have to come face-to-face with it (Taylor, 2008, p. 11). For instance, loaners who get paid a preset fixed amount of interest end up losing in terms of purchasing ability while those indebted get a reprieve of sorts. Employees and pensioners with preset payments also end up the losers in such an arrangement.

Very elevated levels and unforeseen inflation are detrimental to the general financial system (Taylor, 2008, p. 12). If the 2% level can be upheld while at the same time aiming to go lower than that, then the better. With that, it will mean efficiency in the market and it will be a simpler undertaking for companies in their annual budgeting and laying down both short-term and long-term plans.

The productivity of many companies gets slowed down by high inflation since they are compelled to divert resources away from production to lay more emphasis on gains and losses from monetary inflation.

With the future in doubt in high inflation cases, then fewer and fewer investments are bound to be made. This phenomenon also discourages saving. Taxpayers are always on the receiving end in such scenarios since it’s only a few governments that adjust their tax brackets with the prevailing inflation rates (Hilsenrath, 2010, p. 2).

Strains between international business partners are inevitable in cases where the inflation rates differ between the respective economies. Exports from the side with higher inflation are more expensive and will affect the stability of trade if the exchange rates were preset and fixed. Instabilities in monetary exchange rates due to inflation also pose a negative impact on business between the two countries.

Relevance to Corporate Finance

Inflation will always exist in the world financial system, though the rates will always differ from one period to another. Inflation has a few positive effects like providing the possibility for maneuvering for financial institutions in terms of interest rates (Hilsenrath, 2010, p. 2). It also often leads to debt reliefs and labor market adjustments, though the negative impacts surpass these.

What seems workable is being able to maintain the inflation levels as low as possible all the time. The 2% level can be set as the highest tolerable at any given time.

Reference List

Hilsenrath, J. (2010). Low Inflation Always Best? Some Urge a Policy Rethink. Wall.

Street Journal (Eastern Edition), p. A.2. Web.

Taylor, T. (2008). Principles of Economics. Minnesota: Freeload Press.

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IvyPanda. 2022. "Significance of Inflation to Corporate Finance." March 16, 2022. https://ivypanda.com/essays/significance-of-inflation-to-corporate-finance/.

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