How does Inflation affect Firms

How Does Inflation affect Firms?

Inflation imposes various costs on firms. These firms will be worse of the inflation is unexpected. For example, if firms expect inflation of 2%, but, it proves to be 5%, this is worse than if they had expected inflation of 5%.

Some of the costs of inflation

• Menu costs. These are the costs of changing price lists. Modern technology makes it easier to do. But, the higher inflation is, the more frequently price lists will have to be updated.
• Uncertainty and confusion. If inflation is higher than expected, then the costs of investing will be changing frequently. This makes firms less willing to invest because they are uncertain over future costs and returns. This is particularly a problem with unexpected cost push inflation raising the price of raw material costs.
• Wage Inflation. Unexpected inflation may lead to the necessity of renegotiating wage deals with workers. However, these wage rises may be expensive for the firm because they cannot afford them.
• UK Inflation may make UK firms less competitive than international competitors; this is important for exporters.

Benefits of Inflation for Firms

• Reduce Value of Debt. If firms have debt then inflation may reduce the value of debt. In this case inflation is more desirable than deflation, where the real value of debt will be increasing. This also depends on interest rates which affect the real interest rate.
• Low inflation of around 2% suggests economic growth is likely to be high. Moderate inflation makes it easier to change relative prices.