The Effect of High Inflation on Output & Employment

High inflation has the power to decimate savings accounts and render them worthless, while it also can create price and market instability. These negative consequences can, in turn, have an effect on output and the employment rate under certain circumstances. In most cases, high inflation can be preempted by the Federal Reserve Board chairman and the U.S. government. When countries grow concerned over the inflation rate, a natural reaction is raising interest rates.

Inflation occurs due to an expansion in the money supply. In some cases, inflation is a natural byproduct of the Federal Reserve lowering interest rates or engaging in other monetary policies such as quantitative easing. In most cases, expanding the money supply is not the primary intention: the Fed typically lowers interest rates to compel banks to lend more money to consumers and other banks, which in turn stimulates economic activity. However, expanding the money supply also makes prices rise. Inflation, therefore, is a percent change in the rise in the price of goods and services.

According to Michael K. Evans, author of the book, “Macroeconomics for Managers,” employment and high inflation or hyperinflation, are not related. High inflation occurs for reasons that do not have to do with how many workers are producing goods and services. On the other hand, above-average inflation in the short-term improves employment. Because more dollars are in circulation and businesses are taking out more loans to fund operations, companies hire more workers. This boost in the employment rate stimulates consumer spending, which creates a positive growth cycle.

Countries with the economy contingent on exports may increase output during periods of high inflation. For instance, after World War II, many countries systematically devalued their currency in an effort to entice the U.S. to buy their goods and services. Furthermore, consumers increase consumption in the short-term due to the expectation that prices will continue to rise. This expectation compels businesses to increase output.

An exponential rise in prices creates instability. In his book "Survey of Economics," Irvin B. Tucker explains hyperinflation creates a wage-price spiral in which businesses must raise prices and in turn, increase wages. This cycle of rising wages to meet rising prices is self-perpetuating. Businesses cannot easily gauge how much to charge consumers in this instability. Furthermore, high inflation is systemic of other problems in the economy, including steep budget deficits, poor monetary policy and inefficient resource allocation. All of these ancillary problems may cause negative consequences on employment and output.