Effects of inflation

Inflation affects three main areas:

• Resource allocation. The pattern of resource allocation is distorted. Speculative investment in things like real estate, antiques and artwork become popular, as their value tends to go up faster than inflation. Productive investment in capital goods is discouraged, as there is now greater uncertainty and, therefore, risk.
• The share of income and wealth is changed. Some groups 'win' at the expense of others who 'lose'. Those who tend to benefit from inflation include borrowers of funds as the value of their repayments diminishes over time. Those who have market power, including strong trade unions and businesses, that have very little competition; and the government, who gain from bracket creep as workers move into higher tax brackets.
• External stability. a countries inflation rate is higher than that of its trading partners, reduced international competitiveness leads to external instability. The demand for exports falls and local demand for imports increases. The trade deficit (where M is greater than X) rises.

The benefits of achieving low inflation include the following factors:

• improved international competitiveness, as Australian goods and services become relatively cheaper
• a reduction in the trade deficit, as there will be more sales of goods and services
• higher levels of investment, as business becomes more confident
• inflationary expectations are reduced, helping to maintain a low inflation environment.