How exactly can inflation cause poverty? If there’s more money, won’t people just have more of it to offset the increasing prices?

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How exactly can inflation cause poverty? If there’s more money, won’t people just have more of it to offset the increasing prices?

In: Economics

Anyone holding onto money in a bank account or investment with little or no return, or anyone on a relatively fixed income will see a loss of purchasing power with no additional money to make up for it.

People earning money will see incomes rise with inflation, but savings lose value, so peoples retirement/savings funds get hurt.

Wages, savings and fixed pensions, which are tend to be associated with lower incomes, are destroyed by inflation. Investments and businesses, which are more the domain of the well off, increase in value with inflation.

Inflation means that owning cash costs you money.

For example, imagine you have a job paying $10/hr. The first hour you work on Monday earns you $10, but you don’t actually get that money till pay day a week later. Then of course, you don’t spend your money until the end of the week. So, you actually “owned” the $10 for almost 2 weeks between earning it and spending it. In that time, with usual inflation (around 2.5%) your $10 lost about 1c in value. By the time you spent it, it was worth only $9.99. Owning the cash cost you 1c.

At usual inflation rates, this is no big deal. Mostly you only own cash for a week or two, which only costs a few cents, and if you want to hold cash longer, you can find a bank account with enough interest to offset the inflation.

However, if inflation is very high, the cost of owning cash goes up. At 50% (the level at which inflation is thought to become especially harmful) your $10 is worth$9.80 by the time you spend it. At 100% your $10 is worth $9.60 when you spend it. At 1000%, your $10 is worth just $6 by the time you spend it.

The cost of owning cash encourages you to spend your money rather than hoarding it, the higher the cost, the faster you will want to spend it. Eventually, if the cost of ownership rises too high, it starts to make it difficult for regular people to do regular business. If owning $10 costs $4 a fortnight, you’ll probably ask your boss to pay you the same day you work to keep your losses low. That might be hard for your boss to do financially. Similarly, your electric company and cable company are going to want you to pay for the service daily rather than at the end of the month. This makes it harder to make ends meet on a day to day basis. Moreover, you can’t keep a few hundred bucks in savings to help smooth things out. Your savings loses 40% every fortnight, street a couple of months, it’s basically worthless.

So, even if your wages keep pace with prices, your losses from holding unspent cash are much larger with high inflation, and you can’t keep enough savings to cover emergencies or to save for bigger things like cars or houses.

The end result of this difficult business environment is that the general ups and downs of the week become enough to push some company’s out of business. Now some people are unemployed. Their savings will be quickly worthless, and the business environment means that it is unlikely a new job will be created for these people.

Similarly, if you have to take a day off sick and don’t get today’s wages. Suddenly you can’t pay today’s electric bill and by tomorrow, the late fees will be through the roof. You probably won’t recover financially. Eventually the entire economy is in distress / poverty.