3.5: Redistributive Effects of Inflation
The price effect suggests individuals can gain real income by selecting and purchasing goods and services that are increasing in price at a lower rate than alternative selections. The income effect suggests individuals can gain real income when their nominal income increases at a rate larger than the inflation rate. The wealth effect suggests individuals gain when the real value of the assets increases over time.
Uncertainty is one of the immediate outcomes from inflation, as changes in price level affect decisions about consumption or production more difficult. Most economists tend to agree that the inflation rate on average will hover around 3%, though the gap between the expected and the actual rate of inflation can add to those uncertainties. Many labor contracts use this figure for cost of living adjustments. Speculation occurs when individuals base their purchase decisions on their expectations of inflation. If they think inflation will be higher next year, they will purchase the item now before the item's price goes up. Keep in mind the prices of some items decline, while the inflation rate or the level of prices in general increases. Tax bracket creep refers to the additional tax rates earners face as their nominal or current incomes increase. Higher incomes often mean a higher tax bracket. In 2012 in acting to prevent an increase in taxes for most Americans, the US Congress gave some consideration to bracket creep, possibly reflecting some concerns it may hold about the expected rate of inflation for 2013. Deflation danger refers to the fact that deflation may be more difficult to manage than inflation, as the experience of doing so in the US is almost nonexistent. Deflation is the opposite of inflation and means the general level of prices is decreasing. One can imagine how deflation might affect labor contracts and the various consequences of pay raises at a time when prices are falling.
Read this article, which discusses how inflation can distort the allocation of resources and adversely affect economic efficiency.
Read the "Role of Inflation" section to learn about some effects of inflation.