Inflation often has a negative connotation and is considered a problem in the economic context. Inflation that increases drastically can have a number of negative impacts, such as a decrease in the value of the currency, a decrease in people’s purchasing power, an increase in the poverty rate and so on. Therefore, the government often issues certain policies to try to control it.
Even so, inflation also has a positive impact, especially for debtors, entrepreneurs and the government. These positive impacts are often overlooked for discussion, so that the term inflation becomes synonymous with bad conditions, even though this is not always the case.
Then, what are the positive effects of inflation?
1. Positive impact for Debtors
The positive impact of inflation on debtors is that the real value of their debt tends to decrease as the inflation rate increases. This happens because inflation causes a decrease in the purchasing power of money over time. So, when debtors have fixed-rate debt, they will pay back their debt with money that has a lower value.
For example, if someone has a loan of 100 million at fixed interest at a time of 5% inflation per year, then during that period of inflation, the real value of their debt will effectively decrease. In other words, their payment in the form of the same money will be less valuable in terms of purchasing power.
However, the opposite is true for creditors. If the debtor benefits from inflation, then the creditor (the party providing the loan) receives the negative effects. Because at times of inflation, the real value of loan payments received by creditors will decrease, this can reduce the true value of loans that have been given. Therefore, many creditors apply hedging to prevent losses from the decline in value due to inflation.
One form of hedging that is commonly used by creditors is to arrange contracts with a fixed interest rate or impose an adjustment on the interest rate based on the inflation index. For example, if the fixed interest rate on a loan does not contain inflation protection, the lender may apply an adjustment to the interest rate based on the current index of inflation. That way, the real value of loan repayments remains protected from the effects of inflation.
2. Positive impact for entrepreneurs
Entrepreneurs receive a number of benefits during inflationary conditions, such as increased income because the prices of goods and services tend to rise. Especially for entrepreneurs in the service sector, an increase in the prices of goods and services in general during inflation will increase the profits they earn. Because in this case, service entrepreneurs are not too affected by increased production costs and it is easier to make cost efficiencies than entrepreneurs whose products are in the form of goods.
Entrepreneurs whose companies have certain assets as investments will also benefit from an appreciation in the value of the assets. In addition, if entrepreneurs have fixed-rate debt, inflation can reduce the real value of their debt. This makes paying off debt easier as entrepreneurs pay back their debts with money that is of less value in terms of purchasing power.
Even so, some business sectors may actually experience negative effects because inflation is even higher than other business sectors. For example, a sector that relies on imported raw materials could face challenges if inflation causes an increase in the cost of imports. Therefore, entrepreneurs must carefully monitor and adapt their strategy in dealing with the impact of inflation.
3. Positive impact for the government
For the government, inflation conditions can also provide several benefits. For example, fiscal increases, because in a situation of inflation, government revenues from sources such as taxes and customs tend to increase. An increase in the price of goods and services will cause tax revenue to increase because the amount of the tax is related to price. This can help the government to raise fiscal revenues which can then be used to fund development programs, public services, and infrastructure projects.
In addition, if the government owes domestic creditors, meaning the government as a debtor, inflation can reduce the real value of their debt over time. So the government will pay back their debts with money that is less valuable in terms of purchasing power. This would effectively reduce the government’s debt burden and reduce the pressure to pay back the same amount of debt in more valuable money.
Inflation can also stimulate economic growth. When prices increase, consumers tend to spend more at that time to avoid paying higher prices in the future. This can boost aggregate demand and encourage the business sector to increase production and create new jobs.
Inflation basically does not show positive or negative conditions. Because inflation has different contexts, where it can have a positive impact and it can also have a negative impact. For example, as in the points above, inflation can also have a positive impact on debtors, entrepreneurs and the government. However, it should be underlined that positive inflation is inflation that grows at a moderate level. Meanwhile, when inflation growth is too fast and cannot be controlled, these conditions will have negative impacts, as we know about the effects of inflation so far.
Another positive impact of inflation is encouraging innovation and efficiency. When the price of goods and services rises, companies tend to look for ways to reduce production costs in order to remain competitive. This drives innovation in technology and production processes. In addition, inflation can provide incentives for companies to optimize their resource allocation and avoid waste. For example, a study published in the “Journal of Money, Credit and Banking” found that moderate inflation can stimulate the efficiency of the industrial sector in developing countries.
Inflation can also help maintain flexibility in the labor market. When inflation occurs, wage rates generally tend to increase. This can help workers maintain their purchasing power and prevent wage stagnation. In addition, inflation can help reduce uncertainty in wage negotiations between workers and employers, because price increases can provide a basis for wage increases that are more easily accepted by both parties.
