Over time, the price of goods and services generally rises. Measuring the speed of that growth gives us a useful economic tool called inflation.
When inflation is low and under control, there is nothing to be concerned about, but as inflation begins to climb, the economic consequences can be significant. Right now, inflation is on the rise across a number of the world’s biggest economies, including the US.
When economists discuss what causes inflation, they generally cite factors such as higher wages, increased spending, lower sales taxes and falling interest rates. But whatever the cause of inflation, when it rises too much, it can have significant, mostly negative, impacts on businesses of all sizes. These impacts are not always felt equally across all sectors, but in general, rising inflation has nine key impacts.
1. Disruption to supply chains
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High inflation can affect the prices of all commodities and products across an economy. This in turn leads to difficulties for business owners in sourcing essential materials and supplies at a viable cost. That difficulty has a corresponding effect on other businesses in the same supply chain, leading to increased production delays, which in turn results in a decline in revenue.
2. Raw material shortages
As businesses in all sectors attempt to obtain essential materials at the lowest cost, there can often be a resulting effect in the form of shortages of key raw materials. This can compound the supply chain problems mentioned above and further slowdown production, potentially leading to a loss of customers and a negative effect on business revenue.
3. Increased overheads
The combination of supply chain disruption and raw material shortages which lead to rising costs of materials can contribute to higher overheads and to greater inventory costs across all business sectors. This obviously has an impact on a company’s overall economic viability, eroding profits and increasing pressure, particularly on those companies operating on small margins.
4. Rising interest rates
When inflationary pressures increase, central banks such as the Federal Reserve come under pressure to act. Controlling inflation is seen as a key contributor to economic stability and growth, so central banks may raise interest rates in an attempt to control price rises. This increases the cost of borrowing and creates a tougher business environment, both for day-to-day operations and future investment.
5. Falling consumer spending
As price rises accelerate, one consequence is that the purchasing power of ordinary consumers decreases. With extra pressure on household budgets, people are increasingly likely to focus on the essentials and cut back on their spending across the board. This can have a dramatic effect in areas such as retail, where the business model depends on a consistent and predictable level of consumer spending.
6. Investment is tougher
During times of high inflation, investing becomes much harder for two reasons. Firstly, borrowing, which often powers investment in the business sector, is usually more expensive as central banks increase interest rates. Secondly, high inflation means that the potential return on investment is actually lower than inflation, which discourages investment and prevents businesses from growing, in turn impacting profits.
7. Higher wages
High inflation causes significant problems for households as their purchasing power declines, and one inevitable consequence of this pressure is a demand for wage increases. Depending on the sector, employees may be able to move to rivals offering higher pay, and the increased costs of maintaining their workforce will have an additional impact on business profits.
8. Greater competition
Another unwelcome consequence of high inflation is the potential for an increase in the intensity of competition. As revenue declines and costs rise, businesses need to fight harder for market share, which can put negative pressure on margins and trigger a drop in profitability.
9. Old debt is cheaper
There are few positives to higher inflation but the decline in the cost of debt is perhaps the most notable. As inflation rises, the value of old debt decreases. While new debt becomes more expensive, deterring business borrowing, old debt becomes easier to pay off, so businesses that have taken on a lot of debt prior to a period of rising inflation could experience a benefit.
Overall, high inflation is bad news for businesses and makes for tougher economic conditions, putting pressure on every aspect of business operations. That’s why it is vital for businesses to have plans in place to cope with periods of high inflation and to closely watch all the key economic indicators.