Cambridge International as and a level Economics Ebook

Factors aff ecting the consequences of 
inflation
Th
e eff ects of infl ation depend on:
■
 
the cause of inflation
■
 
its rate
■
 
whether the rate is accelerating or stable
■
 
whether the rate is the one that has been expected
■
 
how the rate compares with that of other countries.
Demand-pull infl ation is likely to be less harmful than 
cost-push infl ation. Th
is is because demand-pull infl ation 
is associated with rising output whereas cost-push 
infl ation is associated with falling output.
A high rate of infl ation is likely to cause more damage 
than a low rate especially if the high rate develops 
into hyperinfl ation. Indeed, hyperinfl ation can lead to 
households and fi rms losing faith in the currency and may 
bring down a government.
An accelerating infl ation rate, and indeed even a 
fl uctuating infl ation rate, will cause uncertainty and may 
discourage fi rms from undertaking investment. Th
e need 
to devote more time and eff ort to establishing future 
infl ation will increase costs.
Unanticipated infl ation, which occurs when the 
infl ation rate was diff erent from that expected, can also 
create uncertainty and so can discourage some consumer 
expenditure and investment. In contrast, if households, 
fi rms and the government have correctly anticipated 
infl ation, they can take measures to adapt to it and so 
avoid some of its potentially harmful eff ects. For instance, 
fi rms may have adjusted their prices, nominal interest 
rates may have been changed to maintain real interest rates 
and the government may have adjusted tax brackets, raised 
pensions and public sector wages in line with infl ation.
It is possible for a country to have a relatively high rate 
of infl ation but if it is below that of rival trading partners, 
its products may become more internationally competitive.
TOP TIP
Remember that inflation does not always reduce 
households’ purchasing power. It does 
ceteris 
paribus
, but if wages rise by more than prices, 
households will be able to purchase more goods 
and services.