The Effect of Inflation on the Economy

The Effect of Inflation on the Economy

Several definitions of inflation are in existence. Inflation is a situation in which there is price level or in which there would be such a persistent upward movement but for the presence of direct control over prices.Also, it is “a temporary increase” of the stream of money in circulation of a faster than that of the stream of goods and services on which this stream of money is spent and that money creation is inflationary when the additional purchasing power has no counter part in goods and services people wants to buy.

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Onah (2005) defines inflation as the persistent rise in general price level. In order to observe that there is inflation, there should be a rise in the volume of money credit.   This rise must exceed the available goods and services in the country, there should be a substantial and continued increase in the general price level of goods and services.


Onah (2005) status as follows:

1.     Cost push inflation – this is where inflation is caused  because of increase in cost of production, more especially when there is increase in wages and services.
2.     Demand pull inflation – this is where inflation is coursed by excess demand for goods and services. In this case supply fails to keep pace with demand resulting in demand being more than supply, which increases the price.
3.     The inflationary spiral – the pressure of demand resulting from the existence of large amount of purchasing power will force up the prices of goods and services. In crease in cost of goods and services will lead to demand for wage increase. Wages forces up prices, prices forces up wages.
4.     Artificial scarcity – Inflation can occur in a country where there is artificial scarcity in caused by hoarders, this always happens in Nigeria when goods like fuel, kerosene will suddenly disappear from filing stations.
5.     Population explosion – if population is to increase more than the food production, a time will reach when many months will begin to chase few goods and the high demand for goods and services will push up the prices.

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More money in circulation  – everybody has money but no goods to buy.
Simulation of business activities – since production is done in anticipation of demand and cost do not increase as prices begin to raise profit will be increased; there will be less risk in production.
Full employment – from the above, when business activities increase, businessmen buys and sell their goods with profits. This increase prices and profit are usually associated with increase in employment opportunities.
Values of money falls – In time of inflation the purchasing power of money also falls.
Fixed income earner suffer – Those on weekly or monthly income losses because when once they are being paid at that fixed amount and getting to the market where inflation has taken place, that fixed amount of income can never serve.
Debtor gain while the creditors loss – it is so because when the debtor borrowed this money from the creditor, the money then has value or may be when there is no experience or existence of inflation in the country but the debtor is refunding the money at inflation period when money must have lose it’s values what money can buy than, it can not carry it again because of the inflation and it’s effects.

Johnson (1922) states that inflation is a continuous rise in the price of goods and service as a result of large volume of money in circulation used in the exchange of the few available goods and services


The wholesale price index – this measures the prices of inputs used in the [production of goods like machinery and other equipment, raw materials etc, increase of which will affect price of goods.
The consumer price index-this is the main determination of the level of inflation in a country because it measures the price level of consumer goods.
The GAP index- this measure the total value of goods and services product in a country at a particular period.

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TYPES OF INFLATION        From Anyanele (1992) inflation are divided into two major types sizes.

Ordinary inflation  – this is a gradual and in mitten rise in the price of goods and services caused by, under production, hoarding and increase inn the volume of money in circulation in a country.
Persistent inflation – this is a more continuous sharp and not easy to control rise in the prices of goods and services which occurs mainly as a result of large volume of money in circulation for more than available goods and services.

REDISTRIBUTION OF INCOME                From Gittinger (1986) the two different types of income redistribution may result from inflation. The fairly popular one is the debtor. Creditor case while the second is not easily recognized by the public, come as a tax on real case balance.

As such, if the public has not expected a particular inflation that comes about, one guess that the debtor who borrowed money previously now gains real purchasing power when payment losses. Contracts affected in this way other than ordinary loans include the sale of fixed interest bonds, annuitions, and mortgages whereby the government and firms issuing the bonds gains, the seller of a mortgage whereby the government and firms issuing the bonds gains, the sellers of a mortgage (the borrower who financed a house purchase) gains, while the buyer of the securities losses.

The other type of income redistribution occurs when government expenditure that is financial through money creation (such as borrowing from the central bank) leads to inflation, and purchasing power is then transferred from owners of cash balances to the government, such owners suddenly find the real value of their stock of money declining as well other values rise. Some economist has viewed this as a tax on holders of money very much like a tax on capital.

Under this sub-heading, one may also discuss the welfare cost of inflation. This loss welfare that come about though inflation is due to the fact that as inflation rises several people devote  time and effort to keep down time and effort to keep down their real cash balances by making more frequent trips to the bank to cash their cheques or equity shares. This is certainly a society wasteful activity.

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Thomas (1975) inflation affects investment in various ways for at least two reasons. Firstly Company income tax is bases on fairly rigid rules rather than, say an indexed value of capital. Consequently, inflation turns a company income tax into a tax on capital because part of what should appear as capital shows up as income in the company’s account and it then taxed away normally like an actual profit income. This, even if the firms gross income raise as much the inflation rate, inflation will still have effects of reducing the real resources that could be devoted to investment for replacement and expansion purposes and also for distribution to shareholders.


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