to sell off even their solid capital assets in favor of holding cash or buying gold. There is an investment retrenchment, production is reduced, jobs are eliminated, labor becomes cheaper as unemployment grows, wage-earners have less income to buy goods and services, and the entire economy contracts suddenly, spiraling into a depression – another name for the deflationary period. For the ordinary man, it is indeed depressing, but for capitalist – their money increases in value automatically, and there is no need to incur the risk attached to investment or capital venture. Eventually, the economy begins to recover, production slowly begins to increase, and the inflationary cycle begins again.
General Effects of Inflation
As stated in the introductory paragraph to this article, inflation over the long run is a zero sum game for the society as a whole. In and of itself inflation is neither good nor bad, but an auto-correcting mechanism for balancing money supply with currency value. Once created, money takes on a life of its own, and obeys rules independent of the government that created it.
But inflation can have a very pronounced effect on classes of currency users. Inflation affects borrowers, lenders, and currency deposits differently. Owners of currency, particularly individuals and institutions that have accumulated large amounts of currency (capital), suffer an automatic wealth loss due to the deflation of the currency. That loss of wealth suffered by capital owners is transferred as a wealth gain to borrowers, who repay loans in deflated currency. It is an axiom that capital owners consider inflation as evil, while astute borrowers consider inflation as a boon.
Another class of currency user who is severely affected by inflation is the retiree on a fixed pension. Every year such retirees see their fixed incomes decreasing in value and buying less. Conversely, governments generally see their tax revenues rise, as most taxes are a percentage of the price of goods, which increase with inflation.
Effects on Capital Construction Projects
Inflation may adversely affect a fixed-priced construction project already under contract with a very long duration because the contractor would be paid in increasingly deflated dollars over the life of the project. Contractors bidding on such contracts must anticipate the effects of inflation in their bid. Owners rarely include an adjustment for inflation as part of the contract terms. More commonly, bidders price inflation into their bid by applying an estimated inflation factor to the mid-point of construction. Most construction estimating manuals, such as Means 51, include tables and charts for estimating inflation.
Capital projects in planning are not affected by inflation in real terms. They are routinely estimated in one year's currency (e.g., 1980 dollars), and if delayed, recast in another year's dollar (e.g., 1990 dollars). The cost in original dollars (e.g., 1980 dollars) does not change unless additions or deletions in project scope or made. What changes is that inflated costs (actually deflated dollars) must be accounted for 51, 55.
A cost estimate for a future project is generally priced at published prices for labor, equipment and materials current at the time the estimate is prepared, but project costs can be cast in any year's dollar value. If a future project is deferred from one year to the next (e.g., 1990 to 1991) during a budget processes, future project costs might need to be adjusted for the new