Effects of inflation

Just as how there are two sides to every coin, similarly, there are pros and cons to inflationary growth as well.

Negative effects of high inflation

Falling investment, employment and economic growth

If cost-push inflation is present in the society, firms which do not improve productivity and efficiency, will not be able to keep up with the rising costs and eventually experience a decline in profit. Investments will be discouraged, thus affecting economic growth as well as the unemployment rate. In addition, inflation may discourage savings, which is a key source of funds for investments. This is because inflation causes the real value of savings to fall. People will be encouraged to consume more, propagating the vicious cycle. The result is a loss of business confidence in the economy and the inevitable decline in growth and investments

Decline in net export revenue

A country suffering from high inflation rates will also suffer a simultaneous fall in its exports, as its trading partner switch to relatively cheaper alternatives from other countries. High prices at home will most likely increase the demand for imports, as foreign goods are now relatively cheaper than domestic goods. Thus, a falling export revenue and rising import expenditure will cause the balance of trade to worsen. Ceteris paribus, the balance of payments will also deteriorate and the exchange rate may also weaken.

Severe inflation over a prolonged period of time may also cause businessmen and foreign investors to lose confidence in the local currency and lead to a capital flight if left unchecked. This will worsen the financial account, exacerbate balance of payments problems and hamper economic growth.

Redistribution of income

Inflation causes a redistribution of income, as certain groups of people benefit whilst others suffer from inflation. The “losers” and “winners” are grouped as follows:

Winner	Loser
Variables income earners, income varies in tandem with inflation, hence their real income does not fall.	People whose incomes are fixed in money terms. This group includes those whose incomes are derived from fixed interest-securities, controlled rents and private pension schemes. All recipients of fixed incomes will suffer a fall in their incomes if inflation is higher than the increase in nominal wages.
Debtors (borrowers) Debtors who have debts with a fixed nominal rate of interest will see a reduction in the "real" interest rate as the inflation rate rises. The real interest on a loan is the nominal rate minus the inflation rate.	Creditors (lenders)

Positive effects of low inflation

Contrary to popular belief, inflation isn't necessarily bad for the economy as a whole. Inflation can bring about further economic growth as well.

Promotes business investment, employment and economic growth

Low inflation or price stability provides certainty which makes it easy for investors to make projection on costs and returns of their investments. Higher investments mean a rise in aggregate demand causing the national income to increase by a multiplier effect, and reducing cyclical unemployment.

If inflation is a mild demand-pull, firms may experience higher profit margins amidst the rising prices since factors costs are unlikely to rise in the short-term due to contracts agreed upon earlier. Thus, this will encourage both investment and growth. In the long run, the productive capacity of the economy also increases.

Also, low inflation encourages savings which is needed to fund investments.

Modest increase in prices is also a sign that business in profitable. Demand is buoyant; sales healthy. In short, it is sign of vibrant economic activity and the economy is not in the doldrums.

Increase net export revenue

Low inflation helps to keep export competitive in the international market and hence helps a country to achieve favorable trade balance. When a country has a relatively low inflation rate compared to others, the price of export are relatively cheaper so export revenue will rise.

Also, there will be currency stability. There is no fear of devaluation and potential capital flight if a country is able to export and earn sufficient to pay for their imports and other international obligations.

Encourage consumer spending

Furthermore, in contrast to deflation, a process which discourages consumer spending and hence lower economic growth and possible leading to stagflation, it is better to have moderate amounts of inflation to encourage foreign investment as well as encourage people to spend. This is much more crucial for a country like Singapore, which is highly susceptible to the changes in the global economy. By spending more and obtaining more investment, there is more income flowing in the economy according to Keynes's theory of circular flow, creating a positive cycle where the more income flows into the economy, the more the economy grows and the more income increases.

As a whole, a moderate amount of inflation helps stimulate economic growth as it bolsters and boosts both consumers' and investors' confidence. People are often affected by their expectations in decision making. In anticipation of a future, possible recession, people may choose to save up money and reduce spending in order to be able to cope with the recession. Similarly, when a sustained economic growth is expected, people tend to spend more as a result, resulting in an increased rate of economic growth.