Inflation: Effect of Distribution, Demand-Pull Inflation

Effects of Inflation on Distribution

Inflation leads to inequitable and arbitrary redistribution of income and wealth in the society. It results in all sections of the society in the same way. During inflation, a section of the society may gain while another section may lose. An advantage accruing to one group of people may be at the cost of the other groups. Effects of inflation on different sections of the society are discussed below:

1. Debtors and Creditors

During periods of rising prices, debtors get benefitted and creditors lose. When prices rise, the value of money falls. Although debtors return the same amount of money, they pay less comparing in terms of goods and services. On the other hand, creditors lose. Although they get back the same amount of money which they had lent, they receive less in real terms because the value of money falls. For example, if a person has borrowed Rs. 1000 for a year and the price level has increased by 10% during the year, he will return the same amount of Rs. 1000, but its real value would have fallen by 10% due to rise in prices. Inflation would have opposite effect on creditors. They tend to lose during inflation since the loan repaid and interest received would have less real value as a real result of the rise in prices. They receive the same amount in money terms but less amount in real terms.

2. Salaried Persons

Salaried workers such as clerks, teachers, and other white collar workers lose when there is an occurrence of inflation. The reason is that their salaries are not fast to adjust when prices go rising.

3. Wage Earners 

Wage earners may gain or lose during inflation depending upon the pace with which their wages adjust to rising prices. If their unions are strong enough, they may have chances of getting their wages associated with the cost of living index. In this way, they may be able to protect themselves from the adverse effects of inflation.

4. Fixed Income Group

The recipients of transfer payments like unemployment insurance, pensions, social security, etc. and recipients of rent interest live on fixed incomes. Pensioners get fixed pensions. Likewise, the renter class consisting of interest and rent receivers receive fixed payments. The same is the case with the holders of fixed interest generating securities, debentures, and deposits. All such persons lose because they receive constant payments while the value of money continues to fall with rising prices. Retired people who survive on pensions are likely to lose during inflation for two reasons. Firstly, in many cases pension is fixed so that the money income of the pensioners remains the same during inflation. Even where pensions of the retired civil servants, retired army personnel, and retired teachers are periodically revised, the increase in pension does not keep pace with the rising prices. Secondly, pensioners keep their savings in the form of bank and postal deposits which give them a fixed income in the form of interest.

5. Equity Holders or Investors

Persons who hold shares or stocks of companies clinch during inflation. This is because when prices are rising, business activities expand which increase profits of companies. As profit increases, dividends on equities also rise at a faster rate than prices. But those who invest in debentures, securities, bonds which carry a fixed interest rate suffer during inflation because they receive a fixed sum while the purchasing power is falling.

6. Businessmen

Businessmen of all types, such as producers, traders, and real estate holders gain during periods of inflation or rising prices. When prices are rising, the worth of their inventories (goods in stock) rises in the same proportion. So they gain profit more when they sell their stored commodities.

7. Farmers

Generally, farmers are benefited by the inflation. The prices of production increase due to inflation and usually, they can repay their debt. Farmers, like other producers, tend to gain because the prices of agricultural products outpace the increase in prices of farming inputs.

Demand-pull inflation

Demand-pull inflation occurs when the aggregate demand for goods as well as services surpasses the aggregate supply available at accessible prices (when there is excess demand than supply for goods and services). It is mainly originated by demand raising factors such as an increase in public expenditure, money supply, money supply, population and export and a decrease in tax rate, etc. It is mainly characterized by rising in income, output, and employment with the rise or increase in price level up to full employment and increase in only price level after full employment. Demand-pull inflation is represented in the following figure.

In the figure, AD1 curve intersects AS curve at E1, giving Y1 and P1 the original output and price respectively. An increase in aggregate demand shifts the aggregate demand curve to AD2. This leads to the excess demand of E1H at P1 price necessitating an increase in output and price to eliminate excess demand. New equilibrium takes place at E2 corresponding to an intersection of AD2 with AS. Excess demand pulls up the price and output to P2 and Y2. Thus, one time shift in aggregate demand gives rise to a one-time increase in price. As we know, inflation refers to a persistent rather than one-time rise in the price level. If there is another and yet another increase in demand and thereby rightward shift in the AD curves, there will to another and then yet another increase in the price level. It is obvious from the figure that up to the full employment level of output (YF), an increase in demand results in an increase in both outputs (Y2, YF, etc.) and the price level (P2, P3, etc.). This happens till AD3 demand curve and corresponding P3 price level. But increase in aggregate demand thereafter leads to increase in the price level only.

Causes:

• Increase in money supply: Increasing CRR ratio, by printing notes, open market operation ( Selling securities and bonds for collection of funds)
• Increase in public expenditure: Development and operational expenditure
• Increase in investment expenditure
• Deficit financing: Increase in employment, income, and expenditure
• Increase in export demand
• Increase in population
• Repayment of public debt

Reference

Bernake and Abel, Macroeconomics, Singapore, Pearson Education latest edition