Inlfation Question?

Question

How can a high level of inflation cause an economy to collapse?

I want a very brief explanation please!

Thanks

Answer 1

I actually think NC's answer is wrong - if people are getting rid of money, they would invest as well as consume. In fact, they would invest more since they would no longer hold onto to money and wait for a better investment.

The problem with high levels of inflation though is that no one knows what the inflation rate is going to be, they just know it is bad.

If people knew what the inflation rate was and could adjust to it, then it would not be that bad. There are of course exceptions: people who have lent 30 year fixed mortgages or any long term loans. Also, workers who need to re-adjust their pay may not be great bargainers, and so the more they bargain the less they may get. People on pensions and retirement income made years ago can adjust their salaries. It is a wonder how the economy can work so well under hyper inflation, and that is mainly because the problem is expected vs. unexpected inflation, not the high absolute rate.

When people don't know what the inflation rate is going to be, then in fact the economy will collapse. In effect, no one knows the prices of things, the relative incomes they will receive, and everything just has to be rationed out according to the preferences of a government.

Answer 2

Inflation is just generally increasing prices of goods and services. The old phrase that it '...is too many dollars chasing too few goods' helps visualize it a bit.

The extreme is being seen in Zimbabwe, with pricing likely increasing by 100,000% this year! That means, if it were in US dollars, a $1 candy bar would cost you $100,000.

Hyperinflation in Germany in the early 20's is a great place to look for real world examples of where inflation can go. Check the link for an interesting and informative piece on inflation.

Answer 3

Inflation is a strong disincentive to save; during times of high inflation, people buy whatever they can, just to avoid holding the money quickly losing its value. As a result, there is no investment (and, consequently, no job creation) during hyperinflationary times. No investment means no purchases of capital goods, so capital goods manufacturers shut down. The resulting surge of unemployment and drop in incomes sends ripples throughout the rest of the economy...