World economy is a complex unity of all local economies represented in the world. Due to the continuous processes of globalization and integration, whatever changes take place in one country, they are easily shifted into another area along with all related effects. That could be even compared to “the domino effect”. And it would be a very positive aspect if not for all the bugs and issues which evolve each day on every market, either local or global, influencing the overall situation in one country or the world economy as a whole.
Quite many economic “viruses” can be recalled now as the ones most threatening the security of the modern economic system. In fact there is no country in the world that is not involved in the global policies aimed to eliminate current economic risks. Due to the World Economic Forum Global Risks 2013 Report, the threats are the unmanageable inflation and deflation, prolonged infrastructure neglect, unforeseen negative consequences of regulation, severe income disparity, chronic labor market and fiscal imbalances, extreme volatility in energy and agriculture prices, recurring liquidity crises and others. The question stands only in how well one can cope with the problem; how sufficient a country is in order to eliminate all the negative outcomes; is the issue manageable within a country’s borders or it brings a threat of infecting the economic group to which it belongs.
The global economic system consists of those two major groups of developed and developing countries. In a meanwhile, developed countries form its own high-privilege groups in order to protect themselves from the foregoing issues, which developing countries strive to fight. It would be worth mentioning the example of the European Union with its European Free Trade Association as well as the group of G7 countries (US, UK, France, Germany, Italy, Canada and Japan). Nevertheless, the fact cannot be ignored that the emerging countries also try to form its own unions and have its own agreements so they are not that much vulnerable to common economic issues. Those are the E7 countries, as outlined by PriceWaterhouseCoopers LLC (Hamilton, 2011), China, India, Brazil, Russia, Indonesia, Mexico and Turkey. They are promised to gain more economic power by the time the half of the 21st century passes by. Whatever policies the “stronger” countries pass “Europe is imploding, the UK is contracting, the US is stagnating and, while Asia is cooling, it at least has the policy tools to be able to rebound” (Lyons, 2012). The pace of global growth has slowed down in the past couple of years and all thankfully to the lack of immunity against those previously mentioned global risks being spread by the controversial processes of globalization.
Notwithstanding, all the efforts we can see countries doing to protect themselves, uniting and implementing needed policies, there is still one issue that we are going to discuss among the main threats of the global economy. The inflation, as was mentioned above, grabs its position closer to the TOP of the list of all the issues. Along with the increasing debt levels and unsustainable economies, the inflation brings high level of risk into the policies of some countries, which try to fight the existing fiscal constraints. What is the actual origin of the issue? What harm can inflation do to the specific economies, and as a result, to the global economy? What other issues combine with and feed inflation, so that the government needs to find cure for both? These and many other questions need to be discussed before we can tell for sure how influential this problem is for the modern world economic systems.
Inflation is generally known as the annualized percentage of rise in the price level of goods and services. Most often to be able to get a grip of the price level experts use the consumer price index, sometimes also the personal consumption expenditure deflator and the GDP deflator. Obvious is the fact that it is essential to concentrate more on core inflation, which excludes the influence of volatile prices for food and energy, rather than overall inflation. The study of Robert James Ball “Inflation and the Theory of Money” (2009) also offers a quote defining the whole inflation process as “too much money chasing too few goods”. That supposably implies the existence of specific relation between the money, the supply of goods and their prices, which is in fact quite easy to dispute considering the fact that this statement is not quite neutral in relation to other economic definitions. In the situation of price level rising each unit of currency can buy less goods and services. Based on this presumption it can be judged that inflation is also a situation of reduction of purchasing power of a specific currency per its every unit. For the economy it means that money lose their real value in terms of exchange and account.
What is the reason for inflation to occur? Those can be quite a few, though at first we need to go over the types of inflation currently present in some countries. Depending on the coverage, inflation can be comprehensive or economy wide, covering all inner markets, or sporadic, relating to specific fields of economy. For example, price raise in food market due to the bad climate conditions and poor crop. Divided by the time condition, there is war-time inflation, caused by the hige demand for essential commodities, post-war inflation, caused by the soaring prices while the governmental policies are in a “frozen” state and peace-time inflation, when government expenditures for the development projects are increasing. More often inflation is divided into two simple types – open and suppressed inflation. The first one occurs in free market economy, where prices are set by businesses freely and there is minimum regulation. Its opposite side, the suppressed inflation, occurs when there are many price restrictions set, which consequently result in evolving black markets, bribes, artificial scarcity, etc. The most widespread differentiation of the inflation term is used while judging by the rate of increase in prices. Therefore, the annual rise of prices not more than by 3% can be called the creeping inflation (also mild or low). If the rate of approximately 3% annual price raise holds for a longer period than just a year, then the experts call this inflation chronic or secular. This type of inflation can be also periodical, taking breaks and then repeating again in its own cycle. When the inflation rate goes over 3% but does not reach 10% per year this type is called walking inflation. This is the one which should be a signal for the economy to look deeply into the nature of price raise, as it can easily turn to more damageable running inflation. The last one is said to occur with the rapid 10% to 20% price raise annually. This one, if not being cured, grows into galloping inflation with over 20% but less than 1000% price increase annually. And the last and the most destructive one is hyperinflation with over 1000% price increase annually. The hyperinflation is the situation of never ever seen price raise, when paper money simply lose any value and people start doing trade transactions in gold or silver. One bright example of this paradox is the hyperinflation in Weimar Republic Germany, 1923. People even started to use old barter commerce system to do some transactions. Without doubt, the most unique examples are the Hungarian pengo fall in 1946 and Zimbabwean dollar fall in 2008 with more than 50 million percent annual inflation rate.
As for the primary causes of inflation, there are two theories fighting to be the main explanation of its nature. The monetarism views support the idea of the raise in money supply to be the reason for inflation. On the contrary, the Keynesian views are rather more supportive of the fact that the economy disorder is the one that is being reflected in changing prices. Hence, they argue these changes cannot take place only due to the money supply raise.
With all the causes of the issue still being debated, its consequences are clear - the inflationary state is highly unacceptable as leads to the direct economic downfall. That is where the Central Banks around the world start taking measures in order to lower or at least stabilize the inflation rates in their countries. The Central Banks are usually the main authorities regulating the money supply in the countries. Therefore, they face a hard task of mediators between the government and businesses while tolerating necessary regulations. They all strive for price stability in order to restrain inflation rates from rapid growth. For instance, on the official website of the Bank of England it is outlined “The Bank sets interest rates to keep inflation low to preserve the value of your money” (The Bank of England, 2013). The research conducted by the team of economists from the Federal Reserve Bank of San Francisco collects also the main goal of the US Federal System monetary policy as to promote stable prices. It also outlines the main purpose of the Central Bank of Chile as to keep the inflation rate low and stable, centered on 3%. Other Central Bank that also puts the mark “high priority” on price stabilization is the Bank of Canada with the goal “to contribute to rising living standards for all Canadians through low and stable inflation” (Federal Reserve Bank of San Francisco, 2006). Also according to this research, the European Central Bank statement claims to set the maintaining of the price stability as “the primary objective of the Eurosystem and of the single monetary policy for which it is responsible. This is laid down in the treaty establishing the European Community, Article 105 (1)” (Federal Reserve Bank of San Francisco, 2006).
Holding the evidence of all these governmental institutions fighting inflation, putting all efforts into lowering price level, experts have to be extra careful considering the fact when exactly the inflationary situation occurs. What is that specific estimated general price level and on which basis should we make decision that this specific price level is the critical one? This is usually defined for each country separately, even if it is a part of some association (for example, the European Union). While being a part of a greater unity, each country still has its own tasks to work on.
Apart from understanding the whole process of inflation, we also should define concrete positive and negative effects that are brought along. No doubt, that the negative sides take over the positive ones, but there are some points to add to the “white list”. First of all, inflation, if steady and balancing between 1% and 3%, might be a good reason for the business profits and revenues boost and, simultaneously, the increase in worker payments. As the businesses let themselves raise the prices and get more money, that will lead to the their psychological confidence and bring eagerness to invest and raise their productivity. The government will also be able to find itself in a payoff due to the “fiscal drag effects” caused in many cases by the inflationary processes. In short, the reason for that is the increase in tax. If we take some indirect taxes, like VAT, for instance, the part that is withdrawn as tax is getting bigger with a raise of the price, so the tax revenues flowing to the treasury are also increasing. Other point adding to the positive performance inflation may cause is the possibility of the public sector debts reduction. Inflation may help the borrowers to bring down a bit the real value of their loans and at the same time it will be good for the government as the public debt level will increase. However, all of the outlined consequences of inflation are good as long as they are backed up by its stable and low percentage.
When inflation rates are getting out of the recommended boundaries, inflation is causing too much trouble. Remarkably, this damage is not only the headache of the government or the business sector. The society also finds its own inflation costs. According to the survey conducted by the Yale economist Robert Shiller (Shiller, 1996), the general public finds the following inconveniences caused by the unmanaged inflation: political instability, loss of morale and the considerable damage to the national prestige. In many cases, as has been noted by Shiller, the news about increasing inflation rates caused failures in the elections for some presidents and decrease in their ratings among the electorate. The public polls also acknowledge the fact of strong dissatisfaction the public holds against inflation and regards it as the most important national problem once it is announced (Shiller, 1996). All in all, those would be called the social costs of inflation.
What about the economic costs of inflation? Those actually evolve when the inflation percentage is too high, for instance, when the running or galloping inflation is present in the economy. As if it is stable and low we might rather face foregoing positive effects. Though when the prices go out of control the damage can be as big as irreversible. Different groups can be affected quite harshly. For example, the households which have savings of their own lose a considerable amount of money taking into the account the loss in the real money value. Another risk they might face can occur if their interest rates are lower than actual level of inflation, as in this case, they can get the negative real interest rate. Consequently, it is safe to assume that whatever interest rates banks offer to the potential savers in general, that must be the anticipated level of inflation for that specific period of time. In a meanwhile the borrowers actually happen to be in a better position. They may find themselves more secure at the expense of the last mentioned savers as the real value of their loans slightly erodes. Another thing worth to mention is the so called “wage-price spiral”, when the increase in prices pushes workers into demanding higher wages for themselves, so that they can maintain their real living standards (Riley, 2012). However, the wage question is not the only one problem that arises in terms of labor market. Its most numerous part is represented by those workers whose jobs are low paid. They are as well unprotected by any labor unions, hence, are the most vulnerable. People simply have no ways of asking for higher wages and that is not just an economic issue, it aims to be the social issue as well. Moreover, the high inflation rates are also a cause for higher unemployment. With labor force being one of the key concepts where businesses and the economy stand on, issues on the labor market sure result in serious economic downfall. The lack of professionals and quality remuneration for their work may lead to such damage as direct decrease of GDP. This surely affects the trade performance of the country. Obviously, this situation is not a good sign for the economy and is more of a red light for both the government and the business sector to rethink its policies and seek the ways of collaboration.
The snowball of issues caused by the unmanageable inflation also grows bigger when the processes of business planning are being disrupted. “Budgeting becomes difficult because of the uncertainty created by rising inflation of both prices and costs - and this may reduce planned investment spending” (Riley, 2012).
The overall conclusion we can make while talking about the effects of the inflation is that it is a matter of seldom occurrence that the rates of inflation are constantly low and stable, well maintained and non-risky. Hence, negative consequences ought to be expected more often. However, the most damage comes from the unanticipated inflation. It can cause much uncertainty for businesses and people as its rates cannot be correctly predicted for the nearest future. Usually, it is claimed to be the government’s fault when the inflation forecasts come out to be faulty. This might lead to the income losses and wealth redistribution from one social group to another. People can be easily confused while counting on the nominal value of their income, when in fact part of it is consumed solely by inflation. So despite the fact that they expect some certain percentage of general raise in their earnings, it can be covered up solely or partly by the percentage of inflation raise. This way people will not get any payoff, but the illusion of it.
It is much safer to have an anticipated inflation, which at least gives some possibilities to hedge against currency fluctuations. This goes in regard not only with businesses, it gives some more time for labor unions to bid for higher wages for the union members, thus, may prevent the labor market from rocketing unemployment statistics. Households with savings also get more time and opportunities to switch to different interest rate plans, higher than the predicted inflation rates. Consequently, they do not lose their money, but at least stay on the same level. We are not even talking about earning some add-on to their savings, which is of course their primary aim. Simultaneously lenders can protect themselves by taking time to adjust their interest rates. So both sides can stay on track during the hard times of inflation raise. Talking about businesses as the major group dealing with inflation, they can also win time to adjust prices, collect some resources before the inflation boost. They simply use the technique of “forward business”, when some transactions are done according to the forecasts.
References
Ball, R. J. (2009) Inflation and the Theory of Money. Chicago: Aldine Pub. Co.
Federal Reserve Bank of San Francisco (2006) How does inflation affect economies?
Retreived from: http://www.frbsf.org/education/publications/doctor-econ/2006/march/inflation
Hamilton, S. (2011) G-7 Will Be Overtaken by Emerging Economies by 2032,
PriceWaterhouse Says. Retrieved from: http://www.bloomberg.com/news/2011-01-07/g-7-economy-will-be-overtaken-by-emerging-markets-in-two-decades-pwc-says.html
Lyons, G. (2012) World economy: still divided after all these years. Retrieved from:
http://www.nationmultimedia.com/opinion/World-economy-still-divided-after-all-these-years-30190192.html
Riley, G. (2012) Inflation Consequences. Retrieved from:
http://www.tutor2u.net/economics/revision-notes/a2-macro-consequences-of-inflation.html
Shiller, R. (1996) Why Do People Dislike Inflation? [PDF document]. Retrieved from the
National Bureau of Economic Research Web site: http://www.nber.org/papers/w5539
The Bank of England Official Website (2013) Retrieved from:
http://www.bankofengland.co.uk/Pages/home.aspx
World Economic Forum Global Risks Report (2013) [PDF document]. Retrieved from the
World Economic Forum Web site: http://www.weforum.org/reports/global-risks-2013-eighth-edition-japanese-0
