Explain why the control of inflation is an important objective of government economic policy.

One effect of inflation and a reason for its concern is that income will be likely to be redistributed between the economic agents in an economy. This could be between ‘savers’ and ‘borrowers’ or even between households and the government. It can mean the real value of peoples savings falls, as the money will be able to buy less goods and services than before. People who have borrowed money before the rise in prices will benefit as the amount they have agreed to repay will represent less in real terms. The ways in which resources are transferred from households to the government during inflation is through public sector wages and taxation. The amount people earn tax-free will fall in real terms and the government does not have to necessarily increase public sector workers salaries at a greater rate than inflation so in this way it gains from increased tax revenue.

Inflation can also have affects upon unemployment in an economy. If demand-pull inflation occurs, then theoretically unemployment will not occur because this type of inflation is caused by a use of all resources in the economy. However, if cost-push inflation occurs then unemployment can occur. This is because the cost to suppliers of putting their good on the market would increase. If it were not possible for them to make up the shortfall by increasing the price of the goods accordingly then workers would be made unemployed. Unemployment can also occur as a result of a worsening in the balance of payments deficit. If British goods become more expensive then fewer people abroad would purchase them. The other side of this is that British people would also purchase more foreign-made goods. This would cause unemployment to increase and the Balance of payments to worsen.

It is of great importance to the government to control inflation, as the effects of large rises in the price level can be very damaging to both the economy and the people within it. The government will still want some degree of inflation as the people who usually gain from it ‘borrowers’, people with mortgages and indeed the Government. The main people who suffer most due to inflation are lenders, people on fixed incomes and exporting firms and industries.