Disadvantages of Inflation

Inflation:

Although inflation can have a devastating effect on a nation's economy, it can also offer some benefits when utilized appropriately in an economy. Ironically, deflation (an opposite to inflation) can impact negatively on a nation's economy as it eventually leads it into recession.

It is important to state that inflation is necessary for a nation's economic growth. The problem here is the level or rate of inflation. Infact, low to medium inflation rates can be good for a nation while a high rate of inflation (hyperinflation) ultimately destroys the nation's economy.

You can read on black market, it's advantages and disadvantages here.

Note: Inflation will always result into a redistribution of purchasing power; and as a result, certain people or organization benefits from it while others suffer eventually.

In this article, we will focus on the disadvantages of inflation; but just before that, it will be a good idea if we understood what inflation really is.

Inflation is defined as a gradual and sustained rise in the price of goods and services in relation to their availability.

Please read more on the concept of inflation here.

Disadvantages of Inflation

• People who hold on to large volume of money (cash) suffers

Individuals who hold on to large amount of cash, be it in their homes, offices or a safe box will eventually lose value for their money when inflation creeps into their economy.

Just before inflation, the value of money is always greater. For instance, let's assume a thousand naira could get you a bag (before inflation). However, the price of this bag will increase during inflation but yet, the cash which had been hidden somewhere remains the same. For this reason, the same bag may sell for two thousand naira (₦2,000) during inflation, thus resulting into a loss of monetary value.

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• The rate of inflation growth may become unsustainable

This may result from the events of an economic boom. An instance of an economic boom in Nigeria occured during the period of 'oil boom'. Before this period, the Nigerian Naira had a higher value than the American Dollar. 

During the period of oil boom (1970s), Nigeria abandoned most of her agricultural exports and focused mainly on oil. Fast forward to 2020, the Nigerian nation has become a massive importation country and as a result, one American Dollar ($1) equals ₦385 in the parallel market.

The above paragraph explains why the Nigerian Government spend more on recurrent expenditure and less on capital budget.

Please read more on balance of trade and balance of payments here.

Based on the above fact, the cost of living has become high in Nigeria while the minimum wage remains low.

• Inflation reduces the value of savings

People who received a fixed interest rate from their bank savings may also suffer during the periods of inflation.

As an instance, if an individual has a savings bank account that pays 2% interest rate monthly, such person may actually benefit at the initial stages (when there isn't inflation in the economy). The problem arises when inflation rises to 4%. In this case, the individual loses 2% on his or her monthly savings.

However, the interest might still look good from the account holder's perspective but in reality, he or she spends more (4% more) and receives less (2% interest) in savings. This will even be worsened when there's tax deduction on such savings.

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• People on minimum wages may suffer

If the minimum wage for a country is ₦20,000 (when there isn't inflation), the recipient may feel contented; but the question is:

What happens to the minimum wage when there's an hyperinflation?

Ideally, the government is meant to increase the minimum wage in a corresponding value as the inflation rate but this isn't always the case in some countries; thus the residents receive less (in salary) and pay more for products and services.

Please read on the concept and types of cost here.

Note: Those who receive a fixed minimum wage (or salary) during inflation may delve into criminal acts in order to make ends meet.

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• Pensioners suffer during inflation

Pensioners typically receive a fixed pension over a long period of time. During the period of inflation (where the price of goods and services are increased), the pensioners receive the same amount of money (as pension) but end up spending more. For this reason, pensions are often called defined benefit plan.

Note: Nowadays, the 'defined benefit plan' is becoming obsolete as it's been replaced by a defined contribution plan. Inflation may have little effect on pensioners with 'defined contribution plan'.

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• Inflation discourages economic growth and long term investment

When an economy has an uncertain and confusing periods of high inflation, investors becomes discouraged from investing their hard earned money into such economy.

Note: Investing in a hyperinflated country may result in dalayed profits (from such investment). The investors could even end up at a loss in a constantly inflated economy.

You can read on production and examples of production here.

• Economies become uncompetitive as a result of inflation

This instance is particularly important in countries that uses a general currency, (e.g Euro).

When there's an Inflation in one of the economies of the 'Euro-zone' countries, the specific country involved will not be able to devaluate their currency, thus canceling an attempt to restore its economy.