The effects of inflation are different from one entity to another. That means the impact of inflation does not have a universal effect.
Inflation is the general increase in the price level of goods and services. Therefore, the impact of inflation on producers will be different from consumers. The effect on debtors will also be different from creditors.
Let’s see the effects of inflation on different entities.
Effects of Inflation
Fixed Income Group
There are a lot of people in an economy who depend on a fixed income. Some people rent their houses to get a constant income. Some people invest their money in bank fixed deposits. A few people invest in bonds and debentures to increase their cash flow. Pensioners get their fixed pensions.
All these people have to bear the brunt of inflation. For instance, the price of goods and services rises, but their income does not. Therefore, they become victims of high inflation.
Salaried class includes all those persons who get a salary. There are government employees as well as private employees. The problem arises when their salary becomes slow to get adjusted to the rising inflation.
The government and private sector employees get inflation-adjusted salaries. But, the actual inflation goes higher than their increment. Therefore, they are also victims of high inflation.
Daily Wage Earners
Daily wage earners work regularly and get paid accordingly. The impact of inflation on daily wage earners depend on their working environment. For example, most of the daily wage earners work in unorganized sectors. They don’t have any unions. Therefore, they cannot pressurize their employers to increase their wages. They become victims of high inflation.
At the same time, some daily wage earners work on a contractual basis. They have unions. They can pressurize their employers to increase their wages. But, the process can be a little bit longer. That can cause pain to daily wage workers.
Creditors can be financial institutions or persons. They give money to others at a fixed rate of interest. Therefore, if their interest rate is low, then they suffer.
The value of money might have decreased drastically during their credit cycle. For example, suppose a bank provides housing loans at a fixed rate of 8% per annum, and the rate of inflation during the credit cycle remains 16%. Then, the bank becomes a victim of this high inflation.
Debtors can be financial institutions or persons. They borrow money from others at a fixed rate of interest. Therefore, if they can grow their money faster than the rate of inflation, they win.
As in the above example, if someone borrows money to invest in real estate at a fixed rate of 8%, and the price of real estate appreciates at a rate of 16%, then the debtor is a clear winner. You should assume that he or she books profit at the end of the credit cycle.
Farmers are producers. They produce a variety of farm products. The prices of farm products increase with inflation. They get a better price for their products. The rate of their products goes higher than the cost of production. Therefore, they become winners during inflation.
At the same time, there are a lot of landless farmers. They are just like daily wage earners. They work in the field for their landlords. Therefore, they cannot claim a higher wage despite rising farm products. They are losers in this game.
Self-employed people don’t work for any organization or people. They possess skills in a particular field and charge for the goods or services that they provide. Freelancers, writers, lawyers, salespeople, insurance agents, etc. fall into this category.
They can increase their fees or service charges during inflation. But, it depends on the nature of their work. For instance, a lawyer or a doctor can raise his or her consultation fee, but a salesperson or an insurance agent will not be able to do so.
In another scenario, if a high inflation rate continues over a long period, it is difficult to increase the fee as the demand for services may decrease due to a decrease in the purchasing power of the people.
Equity investors are those people who invest in stocks. The underlying asset of a share is a business. During inflation, the demand and prices of goods and services go up. Therefore, business activities also increase. More production and more profits are common scenarios.
Companies distribute their profits with their shareholders in the form of dividends. The share price of profitable companies also goes up due to growing EPS (Earning Per Share). Consequently, equity investors, as well as traders, get benefits during unanticipated inflation.
Business people are engaged in the production and distribution of goods and services. Therefore, they are producers like farmers. During inflation, the demand for goods and services increases. As a result, companies or service providers have to produce more goods and services and sell those at an inflated price. The prices of raw materials or the cost of production may not increase suddenly. That is the catch.
The previously stored commodities or inventories might have been bought at a cheaper rate. Further, the price of products may not increase at the rate of inflation. Consequently, business people become the winners in the game.
It happens to those businesses that have an economic moat. That means there is less competition, or they can increase their products’ prices despite fierce competition due to their brand value.
Effects of Inflation on the overall economy
The total effect of inflation on the overall economy is mixed.
It encourages spending rather than saving. People like to buy things now as the price of items will increase over time. They want to hoard things that they don’t need shortly.
Business people invest more in their companies to maximize their output due to increased demand. Professional investors invest in gold or equity to reap the benefits.
Inflation causes more inflation as people tend to buy more due to a sustained increase in the price level.
The interest rates get expensive. The central bank raises interest rates to discourage people from taking loans.
These are some of the critical effects of inflation on the overall economy.
Effects of Inflation – Notes
- The effects of inflation are different from one entity to another
- The fixed income group suffers as their income is fixed whereas the price of goods and services continue to rise
- The salaried class generally get an inflation-adjusted salary, but it may not be parallel to the rate of inflation, and their increment may also get delayed
- Daily wage earners who work regularly are struck during inflation
- Contractual workers having unions may pressurize their employers to hike their wages
- Creditors are losers whereas debtors are winners during unexpected inflation
- Farmers receive good returns over their production cost
- Only a few self-employed skilled people can only raise their fees or service charges
- The wealth of equity investors grows during inflation
- Traders or short term investors also take advantage of price fluctuation in the market
- Business people with an economic moat get the maximum benefit during inflation
- Inflation encourages spending than saving
- Investing in businesses, real estate, and gold goes up during inflation
- Inflation causes more inflation
- Interest rates go up during inflation
Effects of Inflation – summing up.
Inflation can have a good or bad impact on the economy. On the right side, more production, more demands, and more spending, more borrowing can boost the economy. At the same time, a reduction in the purchasing power, not saving money, uncontrolled inflation, a higher interest rate, and employment are some of the negative sides of inflation.
Investors and business people take inflation to their side while savers and fixed income groups are hit.
The article’s primary purpose is to create awareness on the effects of inflation so that you can make an informed decision to manage your personal finance.
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