Inflation November 7, 2012 What is inflation? Also mention its relative causes, remedies and kinds.

INFLATION: Inflation is a process in which the price is rising at a rapid rate and the money is losing its value. In the words of Gardner Ackley, Inflation may be defined as a persistent and appreciable rise in general level of average of prices. It may here denote that rising general level of price doesnt mean that all prices are necessarily rising. Even during inflation, the prices of some goods may remain relatively constant and a few others actually falling. Inflation also does not mean that prices of goods rise evenly or proportionately. Inflation is an upward movement in the general (average) level of prices. CAUSES OF INFLATION: The causes of inflation are generally grouped under two main heads (a) Demand Pull Inflation (b) Cost Push Inflation. A. Demand Pull Inflation: Demand pull inflation occurs when aggregate demand for goods exceeds aggregate supply of goods at current prices, thus leading to an increase in the price level. The factors of which bring about increase in aggregate demand for goods or rise in the general level of prices are grouped under two separate heads; (i) (ii) Factors operating on demand side Factors operating on the supply side.

(a)Factors operating on the demand side: These are the factors which bring continuous rise in the general price level. (1) Increase in money supply: An increase in money supply leads to an increase in money income. The increase in money income raises the aggregate demand for goods and services in the country. The supply of money increases when the govt. resorts to deficit financing or the commercial banks expand credit. When too much money chases too few goods, the result is an increase in general price level. (2) Increase in Government expenditure: If there is increase in govt. expenditure due to adoption of development and welfare activities of the country has to flight a war, it causes as increase in govt. expenditure which leads to increase in aggregate demand for goods and services and hence the price level goes up. (3) Increase in private expenditure: A continuous increase in consumption and investment expenditure in the private sector raises the demand for goods and services and leads to inflationary rise in prices.

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Inflation November 7, 2012 (4) Increase in population: The rapid rising population exerts pressure on the demand for goods and services. If the supply of goods and services fail to match with the demand, the general price level moves upward. (5)Black money: The money generated through smuggling, tax evasion etc. raises the demand for luxury and other goods. Hence black money is also one of the causes in raising the aggregate demand for goods and a rise in general price level. (b)Factors causing decrease in supply of goods: If the increase in aggregate demand for goods and services is matched by an increase in the supply of goods, it will not cause inflationary situation. When the aggregate supply of goods is at a slower pace than the growth in aggregate demand, it then causes inflationary rise in prices. The following factors are identified for relatively slower growth in the supply of goods. (i) Lagging agricultural & industrial production: The increase in population, incomes, employment and urbanization exert pressure on the demand for goods and services. However, the agricultural and industrial production grows at a slower pace, due to shortage of essential inputs like fertilizers, water, cement, iron etc. When aggregate demand for goods and services exceeds the aggregate supply of it, it causes a rise in the prices of agricultural and industrial goods. (ii) Inadequate infrastructure facilities: If, in a country there is shortage of power, transport and communication facilities are slow and inefficient, it results in the slowing down of overall production of goods. When the supply of goods falls short of demand, the prices go up in the country. (iii) Long gestation period: If the time lag between investment and the production of goods is long, the shortage of goods will arise. This will also contribute to inflationary pressure in the economy. B. Cost Push Inflation: Cost push inflation occurs when there is an increase in the cost of production of goods and is not associated with excess demand. The main causes of cost push inflation are: (1) Increase in money wage rate: The wage push inflation occurs when strong labour unions manage to press for wage increases in excess of labour productivity. Unit cost of production is thereby raised. The rise in cost of production exerts pressure on sellers to increase prices of goods so as to get profit margin. (2) Profit push inflation: If the producers of certain commodities have monopoly or near monopoly power in the market, they fix up higher profit margins arbitrarily without any increase in other elements of cost. When a few powerful firms increase the profit margins, the smaller firms also tend to mark up their profit margins. The higher profit margins, thus, inflate the price level
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Inflation November 7, 2012

(3) Material push inflation: If there is increase in the prices of some basic materials such as gas, steel, chemicals, oil etc which are used directly or indirectly in almost all industries, it causes an increase in the cost of production and hence in the general price level. (4) Higher taxes: If the government levies new taxes and raises the rates of old taxes the producers generally shift the burden of taxes on to the consumers. The increases in the selling prices of the commodities push up the inflationary trend in the economy. (5) Import prices: If prices of imported goods increase, it also results in the contribution of inflation. KINDS OF INFLATION: Inflation is of different types. It is generally classified on the following basis. On the Basis of Rate of Inflation: (i) Creeping Inflation: It is a situation in which the rise in general price level is at a very slow rate over a period of time. Under creeping inflation, the price level raises upto a rate of 2% per annum. A mild inflation is generally considered a necessary condition of economic growth. (ii) Walking Inflation: Walking inflation is a marked increase in the rate of inflation as compared to creeping inflation. The price rise is around 5% annually. (iii) Running Inflation: Under running inflation, the price increases is about 8% to10% per annum. (iv) Galloping or Hyper Inflation: Galloping inflation is a full inflation. Keynes calls it as the final stage of inflation. It is a stage of inflation which starts after the level of full employment is reached. Here price level rises very rapidly within a short period. On the Basis of Degree of Control: (i) Open Inflation: It is a stage when the rise in price level gets out of control. Milton Friedman describes it as inflationary process in which prices are permitted to rise without being suppressed by government price control or similar measures. (ii) Suppressed Inflation: Under this type of inflation, the government makes efforts to check and control the rise in price level through price and rationing. When price level is suppressed by the above short term measures, it results in many evils such black marketing, hoarding, corruption & profiteering.

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Inflation November 7, 2012 Inflation on the Basis of Causes: (i) Demand Pull Inflation: Inflation caused by increase in aggregate demand, not matched by aggregate supply of goods, resulting in rise of general price level is called demand pull inflation. Demand pull inflation to be simpler, occurs when the demand for goods and services in the country is more than their supply. The effective demand for goods increases due to many factors such as increase in money supply, increase in the demand for goods by the government, increase in the income of various factors of production etc. In short, the excessive increase in the money supply causes inflationary conditions. Demand pull inflation is generally characterized by shortage of goods and shortage of workers. (ii) Cost Push Inflation: Cost push inflation occurs when the increasing cost of production pushes up the general price level. Cost pull inflation occurs when the economy is below full employment with prices rising even though there is no shortage of goods. Cost push inflation is the result of increase in wage costs unaccompanied by corresponding increase in productivity, rise in import prices of goods, depreciation in the external value of the currency, higher mark up etc, etc. (iii) Profit Induced Inflation: Profit inflation is in fact categorized under cost push inflation. When entrepreneur, due to their monopoly position raise the profit margin on goods. It may cause profit push inflation. (iv) Budgetary Inflation: When the government of a country occurs the deficits in the budgets through bank borrowing and creating new money (Deficit Financing), the purchasing power of commodity increases without a simultaneous increase in the production of goods. This leads to rise in the general price level. (v) Monetary Inflation: Milton Friedman is of the firm view that inflation is always and anywhere a monetary phenomenon. According to him, inflation is caused by a too rapid increase in the money supply and by nothing else. (vi) Multi Casual Inflation: Inflation has a number of causes. It may be caused by increase in money supply, excessive wage demands, excess aggregate demand for goods, shortage of goods etc. The chief cause of inflation in one year may not be in the next year. Since inflation is multi causal, therefore a variety of policy measures are needed to deal with it. On the Basis of Employment: (i) Partial Inflation: According to J.M. Keynes, takes place when the general price level rises partly due to an increase in the cost of production of goods and partly due to rise in supply of money before the full employment stage is reached. (ii) Full Inflation: Full inflation prevails when the economy has reached the level of full employment. Any increase in money supply beyond full employment. It is also called as real inflation.
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Inflation November 7, 2012 Anticipated versus Unanticipated Inflation: (i) Anticipated inflation is the rate of inflation which majority of the individual believes will occur. When the rate of inflation (say 6%) turns out to be same (6%) we are then in a situation of fully anticipated inflation. (ii) Unanticipated inflation is that which comes as a surprise to majority of individuals. It can be higher or lower than the rate of anticipated inflation. Remedies of inflation The first panacea for a mismanagement nation is inflation of the currency. The second is war. Both bring a permanent ruin. They both are the refuge of political and economic opportunities. (Ernest Hemingway). To avoid political unrest and harmful, social and economic effects on the economy, it is the main objective of every government to take appropriate measures to control inflation. The main measures which are used to control inflation are (1) MONETARY POLICY (2) FISCAL POLICY and other measures: 1. Monetary Policy Monetary policy is a policy that influences the economy through changes in the money supply and available credit. Monetary policy is adopted by central bank of a country. The various monetary measures which are used to control inflation are grouped under two heads (a) Quantitative controls (b) Qualitative controls. They are (1) Open market operations (2) Variation in bank rates (3) Credit rationing (4) Varying reserve requirements (5) Varying margin requirements (6) Consumer credit regulations. 2. Fiscal Policy Fiscal policy is the deliberate change in either government spending or taxes to stimulate or slow down the economy. It is the budgetary policy of the government relating to taxes public expenditure, public borrowing and deficit financing. Fiscal policy is based upon demand management i.e, raising or lowering the level of aggregate demand by controlling various expenditures, government expenditure, consumption expenditure and investment expenditure. The main fiscal measures are: Changes in taxation

If the Govt: of a country brings about changes in tax rates, it can help stabilization of prices in the country. For example. A decrease in taxes relates increases disposable income in relation to national income hence, consumption rises at every level of national income. With the increase in aggregate demand for goods, the employment goes up in the country. A rise in tax rates has the opposite effect.
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Inflation November 7, 2012 Arise in taxes causes a decrease in disposable income, creates a larger budget deficitand brings relief from inflation. Changes in Govt. Expenditure

If inflation is at or above the level of full employment in the country, the government can bring down price level by curtailing its own unproductive expenditure. Public borrowing

Public borrowing is another effective method of controlling inflation. Public borrowing reduces the aggregate demand for goods and hence price level. Balanced budget Changes

A balanced budget decrease has a mild contractionary effect on national income and hence on bringing down the price level. Control of deficit financing

For financing the budget deficit, the govt. often resorts to deficit financing. The bank borrowing and printing of new notes increases the money supply in the country and pushes up the price level. Deficit financing therefore, should be avoided to control inflation. Others Measures: Apart from fiscal and monetary measures, the other measures which arehelpful in controlling inflation are; (a) Price support programme. (b) Provision subsidies. (c) Arrangements of easy availability of goods on hire purchase to stimulate demand. (d) Imposing direct control on prices of essential items. (e) Rationing of essential consumer goods in case of acute emergency holding of Friday and Sunday markets. Since 1950s the control of inflation has become the chief objective of both developing and developed countries of the world. The government therefore take monetary, fiscal and other measures to combat inflation.

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