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Why high inflation is bad for economy?

Satvir Singh , Last updated: 01 March 2014  

Inflation is buzz word these days. Infact it remains a buzz word most of the times. India is currently going through a phase of high inflation, which is why words ‘controlling inflation’ crop up quite often in Government & RBI policies & statements. Why exactly policy makers want to bring down the inflation in the economy. Here, we will go through some ill effects of high inflation.

The most simple & much talked about effect is that high inflation results in money losing its value at quicker pace. Purchasing power of the rupee in your wallet will be declining very fast when inflation is stubbornly high.

High inflation is also a great enemy of savers. Suppose, if you have money in a bank account earning you interest of 10%, and at the same time, inflation in the economy is also 10%. This actually means that you are earning nothing on your savings. The interest earned is just enough to cover the falling value of money. There is no real earning on your savings. Now, imagine that the inflation rate goes up to 20%. In this scenario, the interest earned on savings is nothing but mirage. In reality, your money is losing its value, as its purchasing power is declining at faster rate. To simplify it, we can say that you can buy more with Rs. 100 today than Rs. 110 at a future point of time. This is the reason why RBI has recently come out with Inflation Indexed Bonds.

Another much mentioned consequence of high inflation is high borrowing costs. To bring down the inflation, central banks usually resort to tight monetary policy, which pushes up interest rates for borrowers. This, in turn, results in slower economic growth of the country, as new investments dry up.

High inflation also means high volatility. High volatility means more uncertainty in already uncertain future. This volatility makes it difficult for decision makers, whether in industry or government, to take future oriented decision.

However, this doesn’t mean a very low inflation will be immensely beneficial to the economy. Infact, RBI has ruled 4-5% inflation as comfortable for India. Countries like Japan are facing the problem of low inflation, or deflation, these days, which also comes with its own set of ill effects. But we will leave those ill effects to be discussed on some other day, maybe on a day when Indian economy will be facing this type of problem.

(P.S. This is my first article. Suggestions & criticism are most welcome.)

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Published by

Satvir Singh
(Newly minted CA)
Category Others   Report

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