High inflation not only leaves you with less money in your wallet and struggles to pay your bills.
It also imposes long-term costs on society and the economy by forcing consumers to invest less, negotiate wages more often and spend time and energy coping with rapidly rising prices, according to a new paper from the Federal Reserve Bank of Cleveland.
The result: distorted markets and an even greater loss of consumer purchasing power, according to an analysis by Cleveland Fed senior research economist Jean-Paul LHuillier Bowles and research analyst Martin DeLuca.
“These frictions…suggest that inflation imposes significant costs on society,” argue the authors in an article titled The Long-Run Costs of Higher Inflation.
In an economy without such distortions, prices are determined by the law of supply and demand: if demand for a good or service exceeds supply, prices will rise and vice versa.
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Annual inflation has declined since hitting a 40-year high of 9.1% in June 2022, but was 3.7% in September and still well above the Federal Reserve’s 2% target.
According to the Cleveland Fed, here are some of the hidden long-term costs of high inflation:
Reduced wealth
To cope with higher prices, consumers need to hold more cash and less money in stocks or mutual funds. The report says this depletes their wealth and forces them to spend time and effort figuring out how much cash they can hold, resources that can be used elsewhere.
Sticky wages and taxes
When prices rise, workers are usually forced to ask for raises. However, some workplaces may discourage employees from asking for more money, resulting in a loss of purchasing power. This could have a ripple effect across the economy: as workers buy fewer goods and services, retailers and service providers who would benefit from their purchases also cut back on their spending.
Additionally, some taxes, such as capital gains taxes on stocks, may increase due to inflation, causing investors to pay more tax even though the inflation-adjusted value of the stock has not changed. This could prompt people to switch investments, causing more market disruption.
Prices sticky
Likewise, it may be easier for some companies to raise prices than others. A gas station may press a button to change a digital sign, while a supermarket may have to manually update the prices of thousands of items.
As a result, lower-cost firms may be more likely to change prices, skewing or distorting consumers’ purchasing decisions.
Lenders are left behind
Interest rates may not keep up with inflation. So a lender, such as a bank, that agrees to a 5% interest rate actually loses money, or purchasing power, if inflation is 10%. Such financial institutions are likely to restrict lending, imposing additional costs on society.
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Shares and real estate
During high inflation, property values tend to increase, but inventories may fall or remain flat as higher costs reduce corporate profits. This may cause investors to shift funds from shares to real estate, which will further increase the costs of raising capital for companies and result in an additional increase in prices.
Moreover, companies with less cash may invest less in research and development, which negatively affects productivity or output per employee and lowers wages.
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