October 13, 2010Inflationby EconomyWatch

Inflation And Economic Growth

Inflation is a condition, when cost of services coupled with goods rise and the entire economy seems to go haywire. Inflation has never done good to the economy. However, whenever there is expected inflation, governments around the world take appropriate steps to minimize the ill effects of inflation to a certain extent. Inflation and economic growth are parallel lines and can never meet. Inflation reduces the value of money and makes it difficult for the common people. Inflation and economic growth are incompatible because the former affects all sectors as indicated by:
  • CPI or Consumer Price Index
    A rise in the CPI indicates inflation. The CPI or the consumer price index is used as an index for salaries, wages, contracted prices, pensions. This is done to adjust with the inflation effects. It is an important economic indicator.

  • GDP or Gross Domestic Product
    The gross domestic product is another important economic indicator and is usually inflation adjusted. This is an important tool for measuring the rate of inflation.

    The important segments, which are hampered include:

    • Investment
    • Interest rates
    • Exchange rates
    • Unemployment
    • Stocks
    • Various monetary policies
    • Various fiscal policies

The effect of inflation and economic growth is manifested in the following cases:
I) Investment:
If the price of goods increases and people have to compensate for the increase in price, they usually make use of their savings. In the event when savings are depleted, fund for investment is no longer available. An individual tends to invest, only if savings of an individual is strong and has sufficient money to meet his daily needs.
II) Interest rates:
Whenever inflation reigns supreme, it is a well known fact that the value of money goes down. This leads to decline in the purchasing power. In the event, when the rate of inflation is high, the interest rates also rise. With increase in both parameters, cost of goods will not remain the same and consequently people will have to shell out more money for the same goods.
III) Exchange rates:
Inflation and economic growth are affected by exchange rates as well. Exchange rates denote the value of money prevailing in different countries. High rate of inflation causes severe fluctuations in exchange rates. This adversely affects trade (export and import), important business transaction across borders, value of money also changes.
IV) Unemployment:
Growth of a nation depends to a large extent on employment. If rate of inflation is high, unemployment rate is low and vice versa. This theory is propounded by economist William Philips and this gave rise to the Philips Curve.
V) Stocks:
The returns a company offer, on investment fully depend on the performance of the company. Past performance, current position of the company and future trends decide how much(money, in form of bonus or dividend) is to be returned to the investors. Owing to inflation, several monetary as well as fiscal policies are impacted.
In reality, low inflation rate and an upward economic growth is never possible. Nevertheless, low inflation rate means slow economic growth. Whenever, money is in excess, there is bidding by the consumers due to which the cost of goods escalate.

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