n lation and     siness    le       7.11
                                                           5. On Income
        effects of InflatIon
                                                           Inflation affects the income of individual and
     There are multi-dimensional effects of inflation      firms alike. An increase in inflation, increases the
     on an economy both at the micro and macro             ‘nominal’ value of income, while the ‘real’ value
     levels. It redistributes income, distorts relative    of income remains the same. Increased price
     prices, destabilises employment, tax, saving and      levels erode the purchasing power of the money
     investment policies, and finally it may bring in
                                                           in the short-run, but in the long-run the income
     recession and depression in an economy. A brief
                                                           levels also increase (making the nominal value of
     and objective overview of the effects of inflation is
                                                           income going upward). It means, in a given period
     given below:
                                                           of time income may go up due to two reasons, viz.,
     1. On Creditors and Debtors                           inflationary situation and increased earning. The
                                                           concept ‘GDP Deflator’ (GDP at current prices
     Inflation redistributes wealth from creditors to      divided by GDP at constant prices) gives the idea
     debtors, i.e., lenders suffer and borrowers benefit
                                                           of ‘inflation effect’ on income over a given period.
     out of inflation. The opposite effect takes place
     when inflation falls (i.e., deflation).               6. On Saving
     2. On lending                                         Holding money does not remain an intelligent
                                                           economic decision (because money loses value
     With the rise in inflation, lending institutions feel
                                                           with every increase in inflation) that is why
     the pressure of higher lending. Institutions don’t
                                                           people visit banks more frequently and try to hold
     revise the nominal rate of interest as the ‘real cost
                                                           least money with themselves and put maximum
     of borrowing’ (i.e., nominal rate of interest minus
                                                           with the banks in their saving accounts. This is
     inflation) falls by the same percentage with which
                                                           also known as the shoe leather cost38 of inflation
     inflation rises.
                                                           (as it consumes the precious time of the people
     3. On Aggregate Demand                                visiting the bank frequently tagging their shoe). It
                                                           means that saving rate increases. But this happens
     Rising inflation indicates rising aggregate demand
                                                           as a short-term effect of inflation. In the long-
     and indicates comparatively lower supply and
                                                           run, higher inflation depletes the saving rate in
     higher purchasing capacity among the consumers.
                                                           an economy. Just the opposite situation arises
     Usually, higher inflation suggests the producers
                                                           when inflation falls or shows falling traits with
     to increase their production level as it is generally
     considered as an indication of higher demand in       decreasing saving, in the short-run and increasing
     the economy.                                          saving in the long-run, respectively.
     4. On Investment                                      7. On Expenditure
     Investment in the economy is boosted by the           Inflation affects both the forms of expenditures
     inflation (in the short-run) because of two reasons:  —consumption as well as investment. Increased
                                                           prices make our consumption levels fall as goods
          (i) Higher inflation indicates higher demand
                                                           and services we buy get costlier. We see a tendency
              and suggests entrepreneurs to expand
                                                           among the people to cut their consumption levels
              their production level, and
                                                           aimed at neutralising the impact of price rise—
         (ii) Higher the inflation, lower the cost of
              loan (as shown above in no. 2)                 38.   Samuelson and Nordhaus, Economics, p. 674.