Page 106 - DECO502_INDIAN_ECONOMIC_POLICY_ENGLISH

Indian Economic Policy

Notes What happens in general, however, is that product prices increase first and at a faster rate, and
input prices (especially wages) increase later and at a lower rate. It is so because, there is always
a time-lag between the rise in output prices and input prices. For example, prices of goods and
services increase first, in general, and wages of labour after a time gap—we know that when
prices of consumer goods increase, dearness allowance is paid after a time gap. This is the
general case.
As a result, wage incomes flow to producers of wage-goods first and at a faster rate than the
reverse flow. Consequently, inflation cause redistribution of income in favour of the producers.
Consequently, rich (firms) get richer and poor (labour) get poorer.
2. Effect of Inflation on Distribution of Wealth
From the view point of analysis here, let us look at wealth as accumulated assets. Assets can be
classified as : (i) price variable assets, and (ii) fixed value assets. Price-variable assets are those
whose prices change with change in the general price level. The money value of price-variable
assets increases, during the period of inflation. Price-variable assets can be further classified as:
(a) physical assets including land, building, automobiles, gold, jewellery, etc., and (b) financial
assets including shares and stocks. The fixed-value assets, on the other hand, are those assets
whose money value remains constant even if the general price level changes. Fixed-value assets
include bonds, term deposits with banks and companies, loans and advances, etc. Like assets,
there are liabilities also. Liabilities are mostly of fixed claim nature like house loans, car loans,
bank loans, and mortgage of property. Let us assume, for the sake of simplicity in the analysis,
that fixed value assets and fixed value liabilities cancel out.
Empirical Evidence : It has been argued above that inflation can, at least theoretically, affect the
distribution of income and wealth under certain conditions. Let us now turn to the question
whether inflation really affects income and wealth distribution. The economists have devoted a
considerable effort and attention to examine the effect of inflation on the distribution of wealth.
A voluminous literature is available on the subject. Empirical studies do not produce conclusive
evidence on the effect of inflation on the distribution of income and wealth. To quote Samuelson
and Nordhaus, “The summary wisdom of these studies indicates that the overall impact is
highly unpredictable.”
3. Effects of Inflation on Different Sections of Society
As noted above, the overall impact of inflation is unpredictable. However, inflation has certain
definite and predictable effect on the income of certain sections of society. These are briefly
discussed below.
Wage Earners : It is a common belief that wage earners are hurt by inflation. Some authors
consider this belief as a myth. In fact, whether wage earners lose or gain by inflation is again a
matter of labour-market conditions. In developed countries labour is, by and large, organized
and labour market is competitive. According to Baumol and Blinder “the average wage typically
rises more or less in step with prices.” This contradicts the ‘popular myth’ that wage earners are,
in general, losers during the period of inflation. They have used US data to show that real wage
“is not systematically eroded by inflation.” They add, “The fact is that in the long-run, wages tend
to outstrip prices as new capital equipment and innovation increase output per worker.”
Fixed income class : The people of the fixed-income category are the net losers during the
period of inflation. The reason is that their income remains constant even during the period of
inflation, but the prices of goods and services they consume increase. As a result, the purchasing
power of their income gets eroded in proportion to the rate of inflation. For example, suppose
that a person earns a fixed annual income of ` 100,000 and that the rate inflation is 10 percent.
It means that if he spends his total income, he can buy goods and services worth only ` 90,000
at the prices in the current year. If prices continue to increase at the rate of 10 percent per
annum, his purchasing power will be reduced to goods and services worth ` 81,000 in the
second year and to worth ` 72,900 in the third year, and so on.

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