Inflation and Its Effects on Investment Essay -- Finance Financial Eco

Inflation and Its Effects on Investment For world economic markets, inflation is a fairly new experience as for much of the pre-twentieth century there had been little upward pressure on prices due to gold and other metallic standards. These backed currencies limited governments’ abilities to create new money. So at the end of the gold standard strong political pressures often caused governments to issue more money increasing the money supply and therefor the price level. Inflation reflects a situation where the demand for goods and services exceeds their supply in the economy(Hall, 1982). Its causes could be triggered by the private sector and the government spending more than their revenues, or by shortfalls in output. Price increases could also be triggered by increases in costs of production. For instance increases in prices of imported raw materials will cause inflation if not managed. Whatever the initial cause, inflation will not persist unless accompanied by sustained increase in money supply. In this sense, inflation is a monetary phenomenon. But what effect does inflation have on the economy and on investment in particular? Inflation causes many distortions in the economy. It hurts people who are retired and living on a fixed income. When prices rise these consumers cannot buy as much as they could previously. This discourages savings due to the fact that the money is worth more presently than in the future. This expectation reduces economic growth because the economy needs a certain level of savings to finance investments which boosts economic growth. Also, inflation makes it harder for businesses to plan for the future. It is very difficult to decide how much to produce, because businesses can... ...hem to make financial decisions. If people cannot trust money then they are less likely to engage in business relationships. This results in lower investment, production and less socially positive interactions. Among other effects, people may start to attempt to trade by other, less efficient, means in order to avoid the unpredictable price levels due to inflation. Bibliography Blume, Marshall. Inflation and Capital Markets. Ballinger, Cambridge, 1978. Hall, Robert ed. Inflation, Causes and Effects. University of Chicago Press, Chicago, 1982. Hellerstein, Rebecca. â€Å"The Impact of Inflation,† Regional Review, Winter 1997, Vol. 7, No. 1. Massimo, Caruso. â€Å"Investment and the Persistence of Price Uncertainty,† Research in economics, Vol. 55, June 2001. Morley, Samuel. The economics of Inflation. Dryden Press, Hinsdale, Ill., 1971.