The Effects of Inflation

There are two general categories of effects due to inflation. The first group of effects are caused by expected inflation. That is, these effects are a result of the inflation that economists and consumers plan on year to year. The second group of effects are caused by unexpected inflation. These effects are a result of inflation above and beyond what was expected by economics and consumers. In general, the effects of unexpected inflation are much more harmful than the effects of expected inflation.

Expected Inflation

The major effects of expected inflation are simply inconveniences. If inflation is expected, people are less likely to hold cash since, over time, this money looses value due to inflation. Instead, people will put cash into interest earning investments to combat the effects of inflation. This can be a bit of a nuisance, since people need money to take care of business. Thus, if consumers expect inflation, they are likely to hold less cash and travel more often to the bank to withdrawal a smaller amount of money. This phenomenon of changed consumer patterns is called the shoeleather cost of inflation, referring to the fact that more frequent trips to the bank will lessen the time it takes to wear out a pair of shoes. The second major inconvenient effect of expected inflation strikes companies that print the prices of their goods and services. If expected inflation makes the real value of the dollar fall over time, firms need to increase their nominal prices to combat the effects of inflation. Unfortunately, this is not always easy, as changing menus, catalogues, and price sheets takes both time and money. The problems of this sort are called the menu costs of inflation. Thus, the two major effects of expected inflation are merely inconveniences in the form of shoeleather costs and menu costs.