If you look back at history, it is easy to see that there are three macroeconomic consequences of inflation. The first is inflation in general destroys business activities. The second is deflation, which is a decrease in purchases and the third is slack. With all these conditions, the supply curve touches a horizontal line and the price level adjusts upwards. This is the first of the three macroeconomic consequences of inflation.
Let us see what happens when there is an increase in the level of inflation. When business activities start to pick up, there is increased demand for goods and services and the businesses start to invest in equipment and in building. With this increase in business activities, inflation forces down the prices of input goods and materials, the cost of business operations, and the cost of employing people increases. With all these activities, it is not long before the economy overheats and inflation forces down the level of business activities.
Due to the above-mentioned macroeconomic effects of inflation, the growth rate of the economy is reduced. When there is a continuous rise in the level of inflation, there will be a tendency for the economy to expand at a faster pace. In fact, the expansion of the economy can outpace the growth rate of the capital market. The capital market is basically the source of finance and money that allows the transfer of assets from the production process to the purchase of raw materials and eventually to business activities.
The second of the three macroeconomic impacts of inflation is deflation. Deflation is basically a decrease in business activities. The main reason for this is that there is a constant increase in the level of input price and business activities are not able to keep up with the increase in the cost of living. The overall economic performance of the country deteriorates. When this happens, the employment rate goes down as well.
The third of the three macroeconomic consequences of inflation is the impact on financial institutions. When there is an increase in the level of inflation, the demand for loans and other financial products decreases. This will ultimately have a negative impact on the financial system of a country. Financial institutions will become less regulated. This will ultimately affect the currency rates and could lead to a situation where the exchange rate against foreign currencies is significantly weakened.
The last of the three macroeconomic impacts of inflation is the impact on the international trade. When there is excessive inflation in a country, it has a significant negative impact on the competitiveness of the domestic market. This may lead to the cessation of exports and imports altogether. As a result, there will be a decline in the foreign exchange rate and this will eventually have an impact on the balance of payments of both countries.