What are the main Retarding Effects of Inflation?

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Another group of economists led by Milton Friedman believes that inflation does not promote economic growth, but on the contrary, acts as a retarding factor. The following arguments have been given by these economists to support their belief.

1. Distorts Saving Habits:

Inflation distorts the saving habits of the people and slows down the rate of capital accumulation in the country. During the period of rising prices, it is not possible for the people to maintain the previous rate of saving. The fixed income groups reduce saving because their real income has fallen.

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2. Discourages Foreign Capital:

Inflation discourages the inflow of foreign capital and renders more difficult the absorption of financing from foreign governments and institutional organisations. It may even drive out the foreign capital already invested in the economy.

3. Discourages Investment:

Inflation discourages investment in basic industries and infrastructural ser­vices which are either price controlled or require longer gestation periods, or both. In this way, inflation tends to disturb the qualitative composition of investment.

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4. Stimulates Speculative Activities:

Inflation stimulates speculative investments in inventories. It puts a premium on speculative activities. The businessmen find it more profitable to speculate in scarce commodities rather than to increase production.

5. Creates Balance of Payment Problems:

Inflation creates balance of payment difficulties in the under­developed countries. Rising domestic price level reduces the volume of exports from these economies.

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On the other hand, since the marginal propensity to import is high in underdeveloped economies, rise in domestic incomes and prices may encourage people to increase imports from abroad.

6. Market Imperfections:

Underdeveloped countries are marked by market imperfections. There is immobility of resources which results in low elasticity’s of supplies. The shortages in supplies in relation to a high demand (as a result of deficit financing) lead only to inflationary rise in prices.

7. Inelastic Food Supply:

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Food supply being inelastic in the underdeveloped economies due to low agricultural productivity, deficit financing tends to result in general and cumulative rise in the price level.

When incomes increase as a result of deficit spending, they tend to rise, through a chain reaction mechanism, first the prices of food articles, secondly the general price level, and thirdly wages, thus creating an inflationary spiral.

8. Raises Cost of Development Projects:

With the rise in prices, the cost of the development projects also rises resulting in still larger doses of deficit financing on the part of the government. This leads to cumulative rise in prices.

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9. Creates Uncertainty in future Expectations:

Inflation by creating uncertainty in future expectations affects investment decisions adversely.

During the phase of continuous rise in prices, trade unions demand higher wages for workers. Strikes, slow-downs and general deterioration in labour efficiency create uncer­tainty in future expectations and thus adversely affect investment.

10. Offsetting Factors:

The transfer of resources from the consumers to the government or to investors as a result of inflationary development policy may be offset (a) by luxury consumption of the entrepreneurial group and (b) by the lower efficiency of government investments.

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