4.6.5—Consequences of inflation

Inflation reduces the purchasing power of money: a given income buys fewer goods and services when prices rise. Its wider effects depend on whether incomes, interest rates and expectations adjust.

Unexpected inflation can transfer real wealth from lenders to borrowers and from people on fixed incomes to those whose incomes rise faster. It can reduce international competitiveness, create menu and shoe-leather costs, and make planning harder; mild predictable inflation may be less disruptive.

A pension fixed in nominal terms loses purchasing power if prices rise 6%. A borrower with a fixed-rate loan may gain in real terms, while a saver’s outcome depends on the real interest rate.

Inflation does not hurt everyone equally, and a wage rise is not a real gain if prices rise by more.