[PDF Notes] What are Stimulating Effects of Inflation?

There is a great controversy among economists as to whether inflation promotes economic development. A group of economists, including Keynes, believe that inflation promotes economic development. The following are their arguments.

1. Increases Investible Profits:

Inflation redistributes income and wealth in favour of the entrepreneurial classes who have high propensity to save. With this redistribution, the profits and savings in the economy will increase.

The increased savings will be used for investment purposes which, in turn, will increase income, output and employment in the economy.

2. Creates Optimistic Conditions:

Inflation creates optimistic conditions m economy and provides fresh opportunities for new business activities, since, during inflation, costs rise less rapidly than the prices, profit margins go up tempting the businessmen to make more and more investments in new productive enterprises.

3. Stimulates Entrepreneurship:

Inflation encourages bold entrepreneurship and rewards investors at the expense of conservative savers and renters.

4. Inflation Tax:

Inflation tax or deficit financing (i.e., covering the budget deficit through printing new money) can provide adequate funds to the government for financing development programmes in under­developed countries.

In an underdeveloped country, where there is little scope for additional taxation due to low income of the people and public borrowing is limited due to low levels of saving, the government can resort to inflation tax to cover the deficit in the budget.

Highlighting the merits of inflation tax, Keynes said, “A government can live by this means when it can live by no other. It is the form of taxation which the public finds hardest to evade and even the weakest government can enforce, when it can enforce nothing else.

The burden of the tax is well spread, cannot be evaded, costs nothing to collect, and falls, in a rough sort of way, in proportion to wealth of the victim.”

5. Utilisation of Resources:

Inflationary increase in aggregate demand permits a fuller utilisation of manpower and other resources of the economy. This leads to the quicker achievement of the objective of full employment of country’s resources.

6. Increasing Demand for Money:

Monetary expansion through deficit financing is essential in the underdeveloped countries not only for mobilisation of resources and their fuller utilisations but also for meeting the continuously increasing demand for money during the early development phase in these countries:

(a) with a continuous increase in investment, aggregate output is likely to increase, thus necessitating a corresponding increase in money supply for transaction purpose,

(b) As the economy grows, the non- monetised sector is gradually transformed into the monetised sector, leading to an increase in the demand for money,

(c) A process of continuous economic development leads to a rise in incomes, thus increasing the demand for cash balances on the part of the public.

(d) Due to increasing foreign aid, the demand for money is likely to increase further.

7. A Necessary Cost:

Some inflationary rise in prices is a necessary consequence of the process of economic development, particularly in the initial stages of development.

In the initial stages of development, the supply of consumer goods does not increase as rapidly as the supply of money.

Thus, inflation becomes inevitable during economic development. In fact inflation and economic growth go together; inflation promotes economic growth and economic growth, in turn, results in inflation.

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