Discuss whether inflation is necessarily harmful [12 marks] (27 minutes)

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Discuss whether inflation is necessarily harmful. [12]

While inflation is not always harmful to the economy, it can, in certain circumstances cause several issues depending on the degree of inflation occurring. One such issue can be the subsequent fall in availability of credit to the population. As, during inflation, prices rise, the purchasing power of any unit of currency falls accordingly. This then affects the availability of credit in two ways, on the one hand, it incentivizes purchases in the present, thus lowering the amount of money people save because more of the disposable income is spend now, hence, if there if less money being saved, there is less money to be loaned out. On the other hand, it directly disincentivises lending money, as, when the money will be repaid in the future, it will have a lower purchasing power than it did initially, essentially causing a negative interest rate to exist unless the nominal interest rate is adjusted according to the inflation rate, however, in the case where the inflation rate is both high and oscillating, this may be very difficult to implement. This decrease in the availability of credit resulting from inflation will then go on to lead to a fall in investments and spending as people are no longer able to finance startups, investments and expenditure through credit. This is then likely to cause a fall in the aggregate demand within the economy as two main components, consumer expenditure and investments, fall, thus causing a fall in real output. This will then likely go on to lead to poor long term economic growth prospects and structural unemployment within the economy as industries are unable to sustain themselves due to poor revenue.
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Another potentially harmful effect of inflation can be on the country’s balance of payments. As inflation causes an increase in the prices of domestic goods, these goods become [not sure if I should say relatively here] more expensive for foreigners to purchase leading to a deterioration of the country’s international competitiveness, thus, provided that the exports are price elastic, the quantity demanded for exports is likely to fall, in turn leading to a worsening of the balance of trade and the current account. Moreover, as hot money flows out of the country due to the persistent fall in ...

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