How Does High Inflation Rate Affect a Country’s Currency
Inflation and currency exchange rates are directly related. Any change in inflation rates will affect the exchange rates positively or negatively. Inflation is the sustained increase in the costs of goods and services at a given time and can affect a country’s economy.
Every country’s central bank sets its inflation threshold that it doesn’t wish to go beyond and seek to avoid deflation. However, a high inflation rate comes with various economic and social costs. The value of a currency suffering high inflation will generally fall.
The Relationship between the Inflation Rate and Value of Currency
Typically, countries with consistently higher inflation rates exhibit falling currency values as their purchasing power decreases relative to other currencies. On the other hand, countries with lower inflation see appreciation in their currencies against others.
Here are the other impacts of high inflation rates on a country’s currency.
1. Distribution of Income
High inflation brings about a deteriorating effect on low-income families and older adults who survive on a fixed income. If expenses rise faster than wages, then there will be a sharp reduction in actual revenues.
Inflation reallocates income and wealth towards groups of people who can evade inflation by shielding their assets in a way that earns more returns.
2. High Cost of Borrowing
High inflation rates lead to higher borrowing costs for businesses and to people who need mortgages and loans. Financial markets shield themselves against increasing prices and upsurge the borrowing cost on short and long-term loans.
3. Government Spending
The high inflation rate instills pressure on a government to raise the value of the state pension. It also forces the administration to increase the joblessness aids and other welfare expenses as the cost of living increases.
4. Negative Real Estate Rates
If interest rates on the bank’s savings accounts are lower than inflation, investors who depend on interest from their savings become poorer. Most real estate investors experience negative rates thanks to high inflation rates.
5. Business Insecurity and Planned Investment
A high inflation rate is not the best for business confidence since firms cannot be sure of their future budgets and prices. The uncertainty causes lower spending on investments, which destroys a country’s productivity growth and long-run productive potential.
6. Competition in Domestic and Foreign Business Markets
Countries with higher inflation rates than others make exports of goods and services less price competitive in global markets. The final results include fewer export orders, lower operating profits and fewer jobs, and a failing country’s trade balance.
7. Functions of Money
High inflation terminates the internal buying power of money and weakens its value as a mode of exchange and as a unit of account. Substitute exchanges that clasp some of their value may take the domestic unit of exchange.
8. Social Costs of High and Unstable Inflation
When a nation records high inflation, it lays pressure on self-governing organizations. That can lead to growing political protest and social conflict.
The fall of absolute living standards stimulates brain drains amongst a country’s self-reliant people, leaving the nation with a weakened labor force. Also, high inflation rates bring to an end the progress in reducing poverty.
Causes of Inflation in a Country
Inflation rates tend to be recurrent in any country. It rises once the economy does well and loosens when shoppers are less optimistic about the economy. So, consumers have to be cautious about their expenditure habits.
Here are various causes of inflation which include the following.
1. Cost-Push Effect
The cost of finished products rises when input costs rise. When manufacturers face high charges of inputs such as utilities, labor, and raw materials, the companies then pass on the amplified production costs to the final user in the form of hiked prices.
For example, when the cost of maize goes up, it also drives up the price of maize flour at the mall. That is because each packet of flour is now costlier for the miller to make. Therefore, the increased input cost is passed on to the final consumer.
2. Exchange Rates
Currently, the world is becoming connected and more globalized. The flux of exchange rates between two countries’ currencies affects the cost of commodities. This leads to inflation in both countries.
Currencies are dynamic such that the value concerning each country’s currency change constantly. If the Canadian dollar falls against the US dollar in a day, it becomes weaker than the USD and makes American imports costlier for Canadians.
The variance of the Canadian dollars means that shippers have to pay more for the same quantity of goods they import from the United States. Importers pass on the increased charges to Canadian buyers by raising their sale prices.
3. Demand-Pull Effect
When an economy is developing, joblessness tends to fall, and salaries rise. Thus people have more money to spend on consumer goods, increasing the demand for these commodities.
To put up and balance the increased demand and thus poise demand with supply, companies raise the cost of the goods leading to inflation.
For example, flowers are popular gifts during valentine such that their demand rises before the day comes. To put up with this demand, manufacturers raise the prices, leading to demand-pull inflation of flowers.
4. Supply of Money
Suppose a country’s government opts to pump more money into the system by printing extra; the increased money supply affects monetary inflation. More money in the system leads to a fall in the currency, hence reducing its procuring power.
Each unit of money becomes valueless than it was before the printing of more money. Besides, more companies become obtainable for the same amount of goods in the economy. The mismatch leads to higher demand and thus higher prices, i.e., inflation.
5. National Debt
The national debt is among the drivers of inflation in an economy. A government can increase its taxes or print more money to pay high debts. Manufacturers pass on their high corporate taxes to consumers by raising the prices of goods, causing inflation.
Now that you know the relationship between inflation and currency value, it is essential to note that inflation is not bad. Inflation becomes a good thing in various economies if it can outpace the growth of the economy. Banks always examine inflation to direct their monetary policy and set their interest rates.