Page 187 - DECO201_MACRO_ECONOMICS_ENGLISH

Macro Economics

Notes 11.1 Consequences of Inflation

Before learning the measure to control inflation, we must know that why we should control
inflation and what consequences does it have that makes it imperative to keep a tab on it.

Inflation has its impact on the industry normally through the impact it exercises on such Macro
Economic variables like interest rate prevailing in the economy, growth rate experienced,
investment and credit off take, et al. besides of course the impact on availability and dearness of
factors of production.

Becoming dearer is the compulsive fallout on the financial sector which is expected to open the
limes of futures trading and other future oriented investment opportunities to meet the present
glut of uncertainty. While the above factors do sound alarming, the same are performing decently
when compared to the 1991 standards.
Inflation and its fallout on the industry can be studied by understanding its affect on the following.

Inflation and Profitability

Uncertainty about costs and rates of return induced by very rapidly rising prices may well lead
to cutbacks in capital investment programmes and this is one of the reasons why we find
inflation and recession together. There may also be squeezes on fixed investment in so far as
stock building pre-empts whatever liquid resources are available.
Other reasons for the combination of inflation and recession are associated with the lags in
reactions to government policies. We find that the prices continue to rise after monetary and
fiscal action has been taken to cut down the level of demand. Hence, the short-term effect of
attempts to contain inflation may well be reductions in output and employment whilst, for a
time, prices are propelled forward by their existing momentum.

Inflation and Labour Productivity

One of the major consequences of inflation is that it is marked with labour unrest. Average
number of days (in million) lost in industrial disputes in India have been as follows:

1991-92 34.57
1992-93 22.97
1993-94 20.44
1995-96 19.20

The private corporate sector, especially the capital intensive ones worry about the effect of
strikes on their profit record and their ability to raise capital in the future.

Inflation, Taxation and the Private Corporate Sector

When the tax rates are at very low levels the fact that corporation taxes are levied on a profit
concept which does not allow for replacement cost of fixed assets or inventories may not be very
important; and similarly with personal income tax rates for incorporated businesses or taxation
of nominal capital gains for any type of business. But when business firms have to face tax rates
at high levels and inflation is proceeding apace, the situation is entirely different. The drastic
effects of inflation plus taxation are compared below.

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