Economics Online Tutor

The Consequences
of Inflation
This page is a brief summary of the consequences of inflation.  It breaks
these consequences down into three categories: redistribution,
uncertainty, and inefficient resource allocation.



Redistribution

Inflation causes a redistribution of wealth due to changes in real interest
rates.  That subject is discussed on
another page of this site.

Inflation also causes redistribution to occur when specific wages and
prices do not adjust with the rate of inflation.  For example, retirees whose
pension payments are fixed at a specific level.  The term "fixed income"
refers to this situation.  Those who receive such payments will face a
decrease in purchasing power during times of inflation.

The effects of redistribution can be minimized if wages and prices are
indexed for inflation.  That is, if the payments are adjusted based on
changes in a relevant price index.




Uncertainty

Inflation creates uncertainty regarding the future profitability of
investments.  This is especially true during times when the inflation rate is
high.  High inflation rates tend to be volatile.  This can cause risk aversion
to investments that could otherwise create future economic growth.

Funds get reallocated from long term to short term projects.  Funds also
get reallocated from interest-sensitive investments, ones that could
produce economic growth, to inflation hedges such as gold and real
estate.  As a result, long term economic growth is decreased.




Inefficient Resource Allocation

Long term contracts become riskier in times of high inflation.  The market
for long term bonds is decreased in favor of short term investments.  
Labor contracts and wage scales are set for shorter periods.  Holding
money becomes risky, because money balances depreciate in value.  All of
this requires that more time be spent on financial transactions, making
less time available for productive activities.

The costs associated with this inefficient resource allocation are called the
shoe-leather costs of inflation.
This page, along with additional commentary, was posted on the "Economics Online
Tutor" Facebook page's timeline on August 29, 2012.