Inflation
Inflation
Inflation
CHARACTERISTICS OF INFLATION
Inflation is desirable in a country at moderate levels. However,
there is no universally acceptable limit of inflation. Depending
on the contribution, a country decides the acceptable limit of
inflation. The concept of inflation can be understood by
studying its characteristics, which are given as follows:
Inflation is followed by price rise.
The cause behind inflation is increase in money supply.
Thus, it is a monetary phenomenon.
Due to interaction among various economic forces,
inflation is also an economic phenomenon. Inflation
occurs in a dynamic environment over a period of time.
Inflation is always scarcity oriented and occurs in
disequilibrium state of economy.
The rise in prices in inflation cannot be reversed.
Inflation is persistent in nature
Types of Inflation
The types of inflation have been classified on the basis of their
varying nature. Generally, the basis of its classification is the
rate of speed, cause, government reaction, and employment
levels.
Walking inflation
A sustainable rise in price level within the range of 3 percent to
6 percent or less than 10 percent is called as walking inflation.
It occurs when mild inflation is not considered or is let to fan
out by the government.
Running inflation
When the rise in prices increase rapidly at a rate of 10 percent
or 20 percent per annum is known as running inflation. As the
inflation rate crosses two-digit figure, economic problems arise.
Running inflation adversely affects the poor and middle class
families and households in the economy.
Hyperinflation
Semi-inflation
The rise in general price level below the level of full
employment is termed as semi-inflation. According to Keynes,
general prices do not rise as long as there are unemployed
resources in the economy. However, when aggregate
expenditure increases by a large portion, costs for some
resources may rise eventually leading to increase in price. This
phenomena is known as semi-inflation.
Pure inflation
The inflation that occurs when the economy is at full
employment level is known as pure inflation. As Keynes states,
at full employment levels, output cannot be increased any
further. Due to this, price level rises in relation to the rise in
demand for commodities. This is termed as pure inflation.
Open inflation
When the government has no control over the price rise and
there are no barriers to price rise, it is termed as open inflation.
In this case, markets for commodities or factors or production
are allowed to function freely with no intervention from the
central authority.
Suppressed inflation
When the government makes efforts to check the price rise
through price control mechanisms, it is called as suppressed
inflation. The government imposes various physical and
monetary controls in order to suppress the extensive increase in
price levels. Although control over price rise helps to keep
inflation under check, it leads to price rise in uncontrolled
resources, consequently resulting in diversion of productive
resources. It may also lead to economic problems like hoarding
of goods, black marketing, corruption, and so on.
For instance, the cost bread that costs $1 has risen to $1.5 in a
month. This may have occurred because of the increase in the
price of wheat or because of the higher wages demanded by
workers in a baking company.
Deficit-induced inflation
An economy faces deficit balance when its expenditures exceed
revenue. In order to meet the gap, the government prints more
money through central bank. So, any price rise in the economy
due to the government’s effort to level of the deficit balance is
called as deficit-induced inflation.
Credit inflation
When financial institutions and commercial banks provide
more loan to the public with a view to earn more profit, the
amount of money in the economy exceeds more than what is
required. The expansion of credit leads to rise in price level and
is termed as credit inflation.
IMPORTANT CONCEPTS
Demand Pull Inflation
This is when the aggregate demand in an economy exceeds the
aggregate supply. This increase in the aggregate demand might
occur due to an increase in the money supply or income or the
level of public expenditure.
Cost-Push Inflation
Supply can also cause inflationary pressure. If the aggregate
demand remains unchanged but the aggregate supply falls due to
exogenous causes, then the price level increases. Take a look at
the graph below:
In the graph above, the equilibrium price is Op and the
equilibrium output is Oq. If the aggregate supply falls, then the
supply curve SS shifts left to reach S1S1.
At this point, there is no excess demand. Hence, you can see that
inflation is a self-limiting phenomenon.
Effects of INFLATION
a. Effects of Inflation on Production
Investors
During inflation, businesses have an opportunity to earn good
profits. Therefore, people who invest in shares during inflation
tend to gain. As the businesses earn higher profits, they usually
distribute the profit among investor and shareholders too.
Primary Causes
In an economy, when the demand for a commodity exceeds its
supply, then the excess demand pushes the price up. On the other
hand, when the factor prices increase, the cost of production rises too.
This leads to an increase in the price level as well.
Deficit Financing of Government Spending
There are times when the spending of Government increases beyond
what taxation can finance. Therefore, in order to incur the extra
expenditure, the Government resorts to deficit financing.
For example, it prints more money and spends it. This, in turn, adds
to inflationary pressure.
Population Growth
As the population grows, it increases the total demand in the market.
Further, excessive demand creates inflation.
Hoarding
Hoarders are people or entities who stockpile commodities and do
not release them to the market. Therefore, there is an artificially
created demand excess in the economy. This also leads to inflation.
Genuine Shortage
It is possible that at certain times, the factors of production are short
in supply. This affects production. Therefore, supply is less than the
demand, leading to an increase in prices and inflation.
Exports
In an economy, the total production must fulfill the domestic as well
as foreign demand. If it fails to meet these demands, then exports
create inflation in the domestic economy.
Trade Unions
Trade union work in favor of the employees. As the prices increase,
these unions demand an increase in wages for workers. This
invariably increases the cost of production and leads to a further
increase in prices.
Tax Reduction
While taxes are known to increase with time,
sometimes, Governments reduce taxes to gain popularity among
people. The people are happy because they have more money in their
hands.
As these indirect taxes increase the total cost for the manufacturers
and/or sellers, they increase the price of the product to have a
minimal impact on their profits.
Price-rise in the International Markets
Some products require to import commodities or factors of
production from the international markets like the United States. If
these markets raise prices of these commodities or factors of
production, then the overall production cost in India increases too.
This leads to inflation in the domestic market.
Non-economic Reasons
There are several non-economic factors which can cause inflation in
an economy. For example, if there is a flood, then crops are
destroyed. This reduces the supply of agricultural products leading to
an increase in the prices of the commodities.
1. Monetary Measures:
The government of a country takes several measures and formulates
policies to control economic activities. Monetary policy is one of the
most commonly used measures taken by the government to control
inflation.
The bank rate is the rate at which the commercial bank gets a
rediscount on loans and advances by the central bank. The increase
in the bank rate results in the rise of rate of interest on loans for the
public. This leads to the reduction in total spending of individuals.
The main reasons for reduction in total expenditure of
individuals are as follows;
(i) Making the borrowing of money costlier:
Refers to the fact that with the rise in the bank rate by the central
bank increases the interest rate on loans and advances by
commercial banks. This makes the borrowing of money expensive
for general public.
2. Fiscal Measures:
Apart from monetary policy, the government also uses fiscal
measures to control inflation. The two main components of fiscal
policy are government revenue and government expenditure. In
fiscal policy, the government controls inflation either by reducing
private spending or by decreasing government expenditure, or by
using both.
3. Price Control:
Another method for ceasing inflation is preventing any further rise
in the prices of goods and services. In this method, inflation is
suppressed by price control, but cannot be controlled for the long
term. In such a case, the basic inflationary pressure in the economy
is not exhibited in the form of rise in prices for a short time. Such
inflation is termed as suppressed inflation.
The historical evidences have shown that price control alone cannot
control inflation, but only reduces the extent of inflation. For
example, at the time of wars, the government of different countries
imposed price controls to prevent any further rise in the prices.
However, prices remain at peak in different economies. This was
because of the reason that inflation was persistent in different
economies, which caused sharp rise in prices. Therefore, it can be
said inflation cannot be ceased unless its cause is determined.