Saturday, August 22, 2009

Economic Effects of Suppressed Inflation

Inflation is often open and suppressed. Inflation is open when “markets for goods or factors of production are allowed to function freely, setting of prices of goods and factors of production without normal interference by authorities”. Thus open inflation is the result of the uninterrupted operation of the market mechanism. There are no checks or controls on the distribution of commodities by the government. Increase in demand and shortage of supplies persist which tend to lead open inflation. Unchecked open inflation ultimately leads to hyper inflation.
On the contrary when government imposes physical and monetary controls to check open inflation; it is known as repressed or suppressed inflation. The market mechanism is not allowed to function normally by the use of licensing price controls and rationing in order to suppress extensive rise in prices. According to Friedman governments themselves are often producers and sellers of wide range of commodities and they want to keep their own prices low by price restriction and controls. This lead to the breakdown of the free price system, further suppressed inflation also results when efforts are made to increase domestic production and reduce import demand by tariffs, import restrictions, limits on foreign loans, voluntary import agreements etc. So long as such control exists, the present demand is post poned and there is division of demand from controlled to uncontrolled commodities. But as soon as these controls are removed there is open inflation.
Suppressed inflation adversely affects the economy of a country. These are mentioned as under.
1. When the distribution of commodities is controlled the prices of uncontrolled commodities rise very high.
2. Suppressed inflation reduces the incentive to work because people do not get the commodities which they want to have.
3. Controlled distribution of goods also leads to mal-allocation of resources. This results in the diversion of productive resources from essential to non essential industries.
4. Frictions increase in the labour market when high inflation is associated with higher unemployment.
5. Suppressed inflation leads to black marketing, corruption, hoarding and profiteering. It invites extra-legal powers of control. Finally it reduces the prospect of anti-inflationary policy being tried at all.


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