FIGHT INFLATION? Central banks the worlds over are obsessed about inflation and, therefore, devote a significant amount of resources at their disposal to fight inflation. Hence, the primary 3 objective of monetary policy is to ensure price stability. The focus on price stability derives from the overwhelming empirical evidence that it is only in the midst of price stability that sustainable growth can be achieved. Price stability does not connote constant (or unchanging) price level, but it simply means that the rate of change of the general price level is such that economic agents do not worry about it. Inflationary conditions imply that the general price level keeps increasing over time. To appreciate the need to fight inflation, it is imperative to understand the implications of frequent price increases in the system. Some of these implications include: ¾ Discouragement of long term planning; ¾ Reduction of savings and capital accumulation; ¾ Reduction of investment; ¾ Shift in the distribution of real income and consequent misallocation of resources; and ¾ Creating uncertainty and distortions in the economy. To avoid any of the situations above, central banks ensure that the price level remains stable. This is achieved by implementing policies that guard against inflation. Indeed, instability in the general price level undermines the function of money as a store of value and discourages investment and growth. C. HOW DOES INFLATION AFFECT THE ORDINARY MAN? Inflation affects different people or economic agents differently. Broadly, there are two economic groups in every society, the fixed income group and the flexible income group. During inflation, those in the first group lose while those in the second group gain. The reason is that the price movement of different goods and services are not uniform. During inflation, most prices rise, but the rate of increase of individual prices differ. Prices of some goods and services rise faster than others while some may even remain unchanged. The poor and the middle classes suffer because their wages and salaries are more or less fixed but the prices of commodities continue to rise. On the other hand, the businessmen, industrialists, traders, real estate holders, speculators and others with variable incomes gain during rising prices. The latter category of persons becomes rich at 4 the cost of the former group. There is transfer of income and wealth from the poor to the rich. More generally, which income group of the society gains or loses from inflation depends on who anticipates inflation and who does not. Those who correctly anticipate inflation can adjust their present earnings, buying, borrowing and lending activities against the loss of income and wealth as a result of inflation. To further determine the effect of inflation on individuals, it will be necessary to discuss the effect of inflation on different groups. a) Creditors and Debtors: When there is inflation, creditors are generally worse off because, the real value of their future claims is reduced to the extent of the rate of inflation. On the other hand, when inflation occurs, debtors tend to pay less in real terms than they had borrowed. Therefore, it could be said that inflation favours debtors at the detriment of creditors. b) Salaried Persons: Those with white-collar jobs lose during inflation because their salaries are slow to adjust when prices are rising. c) Wage Earners: Wage earners may gain or lose depending on the speed with which their wages adjust to rising prices. If their union is strong, they may get their wages linked to the cost of living index. In this way, they may be able to protect themselves from the negative effects of inflation. Most often in real life there is a time lag between the rise in the wages of employees and the rise in price. d) Fixed Income Group: These are recipients of transfer payments such as pensions, unemployment insurance, social security, etc. Recipients of interest and rent also live on fixed incomes. These people lose because they receive fixed payments while the value of money continues to fall with rising prices. e) Equity Holders and Investors: These group of people gain during inflation as the rising prices expand the business activities of the companies and, consequently, increase profit. Thus, dividends on equities also increase. However, those who invest in debentures, bonds, etc, which carry fixed interest 5 rates, lose during inflation because, they receive fixed sum while purchasing power is falling. f) Businessmen: Producers, traders, and real estate holders gain during periods of rising prices. On the contrary, their costs do not rise to the extent of the rise in prices of their goods. When prices rise, the value of the producer’s inventories rise in the same proportion. The same goes for traders in the short run. The holders of real estates also make profit during inflation because the prices of landed property increase much faster than the general price level. However, business decisions are difficult in an environment of unstable price. In the long-run, there could be an increase in wages which will reduce profit thereby, having an adverse effect on future investment. g) Agriculturalists: Agriculturalists are of three types, namely, landlords, peasant proprietors and landless agricultural workers. Landlords lose during rising prices because they get fixed rents. Peasant proprietors who own and cultivate their farms gain. Prices of farm products increase more than the cost of production. Prices of inputs and land revenue do not rise to the same extent as the rise in the prices of farm products. On the other hand, the wages of the landless agricultural workers are not raised by the farm owners, because trade unionism is absent among them. But the prices of consumer goods rise rapidly. So landless agricultural workers are losers. h) Government: Inflation will have both positive and negative effects on the government. The government as a debtor gains at the expense of households who are its principal creditors. This is because interest rates on government bonds are fixed and are not raised to offset expected rise in prices. The government in turn levies less tax to service and retire its debt. With inflation, even the real value of taxes is reduced. Inflation helps the government in financing its activities through inflationary finance. As the money income of people increases, government collects that in the form of taxes on incomes and commodities. So the revenue of the government increases during rising prices.
