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Inflation is a sustained rise in the general price levels of goods and services within an economy. It has remained a global phenomenon post COVID-19, where 2023 will often be referred to as the ‘year of inflation’. At the beginning of 2023, inflation in the UK stood at 9.2%, one of the highest levels in the last 40 years. It has reduced dramatically since then but it remains critical to assess its effects on people’s life through the dichotomy between the effects of fully anticipated inflation and unanticipated inflation.
Fully anticipated inflation is when inflation is expected and predicted by the government. Here, the effects on people’s lives include increased transfer payments, adjusted tax thresholds and increased nominal wages. For instance, an increase in transfer payments could be seen through the Energy Bills Support Scheme in 2022, where millions of households across Britain received non-repayable discounts on their energy bills. Lowered tax thresholds can similarly maintain economic activity during inflation, and minimise fiscal drag. This means people will pay the same real amount of tax during times of inflation rather than paying a higher amount. Even so, this has an opportunity cost as government tax revenues do not increase from the nominal rise in incomes. There is no ‘inflation illusion’ on workers and employers, workers will not confuse nominal and real wages, such that they will be expected to demand full compensation in terms of higher nominal wages to offset any anticipated inflation. These reserved effects show how fully anticipated inflation can be managed and mitigated aptly provided that the government is proactive in its approach.
Check out this fantastic video by The Economist on the Actions of Central Banks in Controlling Inflation
Unanticipated inflation is when there is a general rise in prices that was unexpected. Consequences for individuals can be uncertainty and income redistribution effects. Consumer confidence decreases indefinitely, which can affect demand for goods and also in turn lead to increased saving, thus reducing the volume of money in the circular flow of income model. This can affect interest rates, as the government may try to reduce the stagnation of the economy by decreasing interest rates to encourage spending. On a larger scale, this uncertainty may discourage investment expenditure by the private sector with negative consequences for output and long-term economic growth. Redistribution of income occurs because some wages and salaries increase more rapidly than the price level while some increase more slowly. Those with rapidly increasing salaries tend to have strong bargaining power which can be a result of strongly unionized workers. Those whose wages aren’t increasing are the worst affected, as they can no longer afford to maintain their previous quality of life. Inflation has undoubtedly led to the tension between employers and workers, the development of this relationship has been rushed by COVID-19 with the number of people with union memberships increasing every year in both the UK and US.
The effects of inflation depend on the competency of the government to predict and mitigate it. Unanticipated inflation has dire effects on people’s lives as it forces policy-makers to be reactive whereas fully anticipated inflation allows for policy-makers to be proactive, mitigating any subsequent effects on people’s lives allowing them to maintain their standard of living. Inflation very much remains a pressing global issue today but with strongly unionised workers and prediction strategies; its effects on people’s lives could be minimised.
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