Q.
a) Define inflation and discuss the measures implemented by the government to control inflation. (15 marks)
b) "There are always winners and losers in inflation". Explain. (5 marks)
(20 marks, 2014 Q6)
A.
b) A good article was published by Emmanuel Adewoyin below:
Winners and losers of inflation
Inflation certainly creates winners and losers. To understand who wins it is important to know why it is sometimes allowed to happen. People and institutions sometimes plan for it and build it into their decision making. If inflation is unforeseen, it creates a win-lose situation in society.
Inflation can be described as an increase in price and a decrease in money purchasing power. The rate at which the level of prices of goods and services are rising. Borrowers profit from the increase in prices or reduction in purchasing powers. Usually, when government, businesses or individual lend, it comes with a fixed rate of interest that includes some level of inflation built on it. When inflation occurs, the higher it get, there will be a value of reduction in borrower’s debt. For instance, if a bank lends millions of pound at a fixed interest rate of maybe 5%, and inflation rate increases from 2% to 4% unexpectedly, then borrowers real interest would be reduced from 3% to 1%. Meaning that the money which was lent has become more precious than the money that is being repaid.
A group that profits or benefits from increase in consumers prices are producers but in the short run. When inflation happens unexpectedly, consumer prices rises while employee’s wages stays the same (stagnant). This gives or generates higher profits for producers until employees wages are amended to reflect the prices consumer pays.
Couple of years ago, many governments in developing countries tried to get rid of their foreign debt by printing their currency in surplus. They would reduce the value of their currency to satisfy their debt. The debt of the United States is huge, and there are fears that American might be tempted to take the same measures. But most developed countries have independent central bank to make sure they oversee on governments incentive to overprint their currency. In the United States, the Federal Reserve is protected from any unpleasant or political pressure and can severely restrict money supply when governments plans are to increase it.
Inflation certainly causes more harms than good. Lenders and savers can both lose when inflation exceeds expectation. They earn interest rates, but when the actual rates exceed the expected rate, they both get harmed. People on low incomes find it really tough during inflation. They tend to have their wealth in cash, whilst those with higher income are more likely to have their wealth in real and financial assets. Stockholders who invest in stocks are winners because, they get some protection as the same factors that raise the price of goods is also the same that raises the values of companies. Another are those with fixed-rate mortgages benefits from inflation because, they pay back with devalued currency. People on low income suffer because inflation destroys the value of their chief assets (cash).
Those on fixed incomes will also find it difficult during inflation. Unexpected inflation on fixed income earners sees their income decline. Retired people are dependant on fixed pension loses purchasing power because the rate of inflation exceeds the rate at which their pay increases. During inflation, money loses value and consumer spend often as they want to spend all the money they have.
EMMANUEL ADEWOYIN
M00476497
Reference
http://www.netplaces.com/economics/inflation/who-gains-and-who-loses-from-inflation.htm
http://www.bankrate.com/finance/investing/winners-and-losers-if-inflation-skyrockets-1.aspx