Inflation is a general and ongoing rise in the level of prices in an entire economy.

Inflation
does not refer to a change in relative prices. A relative price change occurs when you see that
the price of tuition has risen, but the price of laptops has fallen. Inflation, on the other hand,
means that there is pressure for prices to rise in most markets in the economy. In addition,
price increases in the supply-and-demand model were one-time events, representing a shift
from a previous equilibrium to a new one. Inflation implies an ongoing rise in prices. If
inflation happened for one year and then stopped—well, then it would not be inflation any
more.

This chapter begins by showing how to combine prices of individual goods and services to
create a measure of overall inflation. It discusses the historical and recent experience of
inflation, both in the United States and in other countries around the world. Other chapters
have sometimes included a note under an exhibit or a parenthetical reminder in the text
saying that the numbers have been adjusted for inflation. In this chapter, it is time to show
how to use inflation statistics to adjust other economic variables, so that you can tell how
much of, say, the rise in GDP over different periods of time can be attributed to an actual
increase in the production of goods and services and how much should be attributed to the
fact that prices for most things have risen.

Inflation has consequences for people and firms throughout the economy, in their roles as
lenders and borrowers, wage-earners, taxpayers, and consumers. The chapter concludes with
a discussion of some imperfections and biases in the inflation statistics, and a preview of
policies for fighting inflation that will be discussed in other chapter Introduction Inflation is
price raise of goods and services, which decrease the purchasing capacity of the people. When the
general price level rises, for every each unit of currency fewer goods and services can be purchased.
Consequently, the purchasing power of customer would gradually decrease. In this situation the real
value of currency would loss, the value of goods and services will increase. The best method of price
inflation is inflation rate the annual percentage changes in the price. The annualized inflation rate in
India is 8.9% as of June 2012, per the Indian Ministry of Statistics and Programme Implementation.
This represents a modest reduction from the previous annual figure of 9.6% for June 2011. Inflation
rates in India are usually quoted as changes in the Wholesale Price Index, for all commodities. The
inflation rate in India was recorded at 6.1% in August 2013. Historically, from 1969 until 2013, the
inflation rate in India averaged 7.7% reaching an all time high of 34.7% in September 1974 and a
record low of - 11.3% in May 1976.The inflation rate for Primary Articles is currently at 9.8% (as of
2012). This breaks down into a rate 7.3% for Food, 9.6% for Non-Food Agriculturals, and 26.6% for
Mining Products. The inflation rate for Fuel and Power is at 14.0%. Finally, the inflation rate for
Manufactured Articles is currently at 7.3%1 .

In economics, inflation is a sustained increase in the general price

level of goods and services in an economy over a period of
time.[1][2][3][4] When the general price level rises, each unit of currency
buys fewer goods and services; consequently, inflation reflects a
reduction in the purchasing power per unit of money – a loss of real
value in the medium of exchange and unit of account within the
economy.[5][6] A chief measure of price inflation is the inflation rate,
the annualized percentage change in a general price index, usually
the consumer price index, over time.[7] The opposite of inflation
is deflation (negative inflation rate).
Inflation affects economies in various positive and negative ways.
The negative effects of inflation include an increase in
the opportunity cost of holding money, uncertainty over future
inflation which may discourage investment and savings, and if
inflation were rapid enough, shortages of goods as consumers
begin hoarding out of concern that prices will increase in the future.
Positive effects include reducing unemployment due to nominal
wage rigidity,[8] allowing the central bank more leeway in carrying
out monetary policy, encouraging loans and investment instead of
money hoarding, and avoiding the inefficiencies associated with
deflation.
Economists generally believe that the high rates of inflation
and hyperinflation are caused by an excessive growth of the money
supply.[9] Views on which factors determine low to moderate rates of
inflation are more varied. Low or moderate inflation may be
attributed to fluctuations in real demand for goods and services, or
changes in available supplies such as during scarcities.[10] However,
the consensus view is that a long sustained period of inflation is
caused by money supply growing faster than the rate of economic
growth.[11][12]
Today, most economists favor a low and steady rate of
inflation.[13] Low (as opposed to zero or negative) inflation
reduces the severity of economic recessions by enabling the
labor market to adjust more quickly in a downturn, and
reduces the risk that a liquidity trap prevents monetary
policy from stabilizing the economy.[14] The task of keeping the
rate of inflation low and stable is usually given to monetary
authorities. Generally, these monetary authorities are
the central banks that control monetary policy through the
setting of interest rates, through open market operations, and
through the setting of banking reserve requ
1. Meaning of Inflation

To the neo-classical and their followers at the

University of Chicago, inflation is
fundamentally a monetary phenomenon. In the
words of Friedman, “Inflation is always and
everywhere a monetary phenomenon…and can
be produced only by a more rapid increase in
the quantity of money than output.’” But
economists do not agree that money supply
alone is the cause of inflation.

As pointed out by Hicks, “Our present troubles

are not of a monetary character.” Economists,
therefore, define inflation in terms of a
continuous rise in prices. Johnson defines
“inflation as a sustained rise”4 in prices.
Brooman defines it as “a continuing increase in
the general price level.”5 Shapiro also defines
inflation in a similar vein “as a persistent and
appreciable rise in the general level of prices.”
Demberg and McDougall are more explicit
when they write that “the term usually refers to
a continuing rise in prices as measured by an
index such as the consumer price index (CPI)
or by the implicit price deflator for gross
national product.”
However, it is essential to understand that a
sustained rise in prices may be of various
magnitudes. Accordingly, different names have
been given to inflation depending upon the rate
of rise in prices.
irements.[15]
Definition -
o “Inflation is State in which the Value of Money
is Falling and the Prices are rising.”
o In Economics, the Word inflation Refers to
General rise in Prices Measured against a
Standard Level of Purchasing Power.
Types of Inflation –

Explication -
o Demand Pull Inflation – Inflation created and
sustained by excess of aggregate demand for
goods and services over the aggregate supply
. In other words , demand pull inflation takes
place when increase in production lags behind
the increase in money supply
o Cost Pull Inflation – Inflation which is created
and sustained by increase in cost of
production which is independent of the state of
demand (e.g. Trade unions can bargain for
higher wages and hence contributes to
inflation)
o Stagflation – In this types there is fall in the
output and employment levels . Due to various
pressure , the entrepreneurs have to raise
price to maintain their margin of profits . But
as they only partially succeed in raising the
prices , they are faced with a situation of
declining output and investment . Thus on one
side there is a rise in the general price level
and on the other side there is a fall in the
output and employment .
o Open Inflation - The rate where Costs rise
due to Economic trends of Spending Products
and Services.
o Suppressed Inflation - Existing inflation
disguised by government Price controls or
other interference in the economy such as
subsidies. Such suppression, nevertheless,
can only be temporary because no
governmental measure can completely
contain accelerating inflation in the long run. It
is Also Called Repressed Inflation.
o Galloping Inflation - Very Rapid Inflation
which is almost impossible to reduce.
o Creeping Inflation - Circumstance where the
inflation of a nation increases gradually, but
 continually, over time. This tends to be a
typically pattern for many nations. Although
the increase is relatively small in the short-
term, as it continues over time the effect will
become greater and greater.
o Hyper Inflation - Hyperinflation is caused
mainly by excessive deficit spending (financed
by printing more money) by a government,
some economists believe that social
breakdown leads to hyperinflation (not vice
versa), and that its roots lie in political rather
than economic causes.

Causes of Inflation -
Factors on Demand Sides –

o Increase in money supply

o Increase in Export
o Increase in disposable income
o Deficit financing
o Foreign exchange reserves

Factors on Supply Side –

o Rise in administered prices

o Erratic agriculture growth
o Agricultural price policy
o Inadequate industrial growth
Black money (fake currency)
Increase in public expenditure
Decrease in the aggregate supply of goods and
services

Effect of Inflation –
o They add inefficiencies in the market, and
make it difficult for companies to budget or
plan long-term.
o Uncertainty about the future purchasing power
of money discourages investment and saving.
o There can also be negative impacts to trade
from an increased instability in currency
exchange prices caused by unpredictable
inflation.
o Higher income tax rates.
o Inflation rate in the economy is higher than
rates in other countries; this will increase
imports and reduce exports, leading to a
deficit in the balance of trade.

Measurement of Inflation –
The 2 ways of Measuring Inflation are –
1.CPI
 2.PPI
o Inflation is measured by general prices index .

General price index measures the changes in

average prices of goods and services . A base
year is selected and its index is assumed as
100 and on this basis price index for the
current year is calculated . If the index of the
current year is below 100 , it indicates the
state of deflation and , on the contrary , If the
index of the current year is above 100 it
indicate the state of inflation
o Inflation rate and the value of money (Or the

purchasing power of money ) are inversely

correlated . Hence , the value of money can
also be measured with the help of price
indices . The value of money declines when
price index goes up and Vice-Versa.
Consequences of Inflation –
o Adverse effect on production
o Adverse effect on distribution of income
o Obstacle to development
o Changes in relative prices
o Adverse effect on the B.O.P (Balance of
Payment)

Measures of Inflation –
Monetary policy
o Credit Control
 o Demonetization of Currency
o Issue of New Currency

Fiscal policy
o Reduction in Unnecessary Expenditure
o Increase in Taxes
o Increase in Savings
o Surplus Budgets
o Public Debt

Other Measures
o To Increase Production
o Rational Wage Policy
o Price Control

Inflation a threat to Indian economy -

o Inflation has become a household name for
millions of Indians who are finding it extremely
difficult to make both ends meet. Prices are
growing faster than the household income
almost for all products and services including
real estate, food, transportation, luxuries.
o The global economic crisis saw many
economies stumble but India rebounded faster
 and was surging ahead with a growth rate of
9%. But the inflationary pressure is forcing the
government to adopt measures which are
taking the steam out of the Indian growth
story
o For the last two years India is witnessing
double digit food inflation which had reached a
high of around 18% in December 2010 with
prices of onions, garlic and tomatoes
skyrocketing. Lentils, milk and meat have
witnessed a steady rise in prices which is
putting pressure on the home budget of
millions of Indians.
o Millions of poor people in India are struggling
to arrange a two-square meal for their family
members. We are running the risk of having
an entire generation of malnourished children
who are otherwise considered the future of
India.
o The tightening of the economy may control
inflation in the long run but it is also slowing
our economy and as predicted by the IMF
India’s growth will be only around 6-7%
instead of 9%.

Current status of inflation in India –

o Currently inflation rate is around 9.44% in
India, much above the acceptable rate of 5%.
 o The food price index is at 8.31% causing
much discomfort to the policymakers. which
under the current scenario seems impossible.

How to Control Inflation –

Monetary Measures –
o Credit Control
o Issue of new currency

Fiscal Measures –
o Reduction in Unnecessary Expenditure
o Increase in taxes
o Increase in savings
o Surplus Budgets
o Public Debts
o To increase in production
o Rational wage policy
o Price control
o Rationing
Review of Literature
According to some analytical study inflation become major issue for both academics
and policymaker s. They explained about how it is hindrances to the growth of the
nation. They have did clear analysis over the past five years, particularly on food
inflation, demand and supply side factors behind surging food prices. Pointing out that
how the policies are impacting on raising and falling of food articles and its prices. They
emphasized on the increasing agricultural productivity2 . According to Assoc ham Eco
Pulse study FY 2009-2010 the inflation is averaged near 5%. According to AEP study
titled inflation concerns for the Indian economy stated the surge in international
commodity markets led by energy (crude oil, natural gas and coal), metals (copper,
aluminum and iron ore) and food (cereal and meat) is likely to push the domestic prices
up once the heavy fiscal and monetary measures taken as the crisis response starts to
firm up the economic activity3 . According to some school of thought, they explained
about what is the best measure for inflation. Which is the suitable measure and relevant
for monetary policy. In the present conditions of the economy, Consumer price index
for industrial workers (CPI-IW) is preferable to either the wholesale price index or the
GDP deflator4 . According to some analytical frame work, they studied that aims at
empirically identifying the determinants of inflation in india.In a cointigrated vector
auto regression (VAR) framework, the empirical estimation is carried out. The error
correction mechanism (ECM) of the cointegrated variables is also carried out. The
impulse Response function (IRF) of the cointegrated VAR system shows that there is a
lag in the VAR System. There is a systematic analysis which is the best measure for
inflation and what causes for inflation5
 Advantages of Inflation
 Deflation is potentially very damaging to the economy and
can lead to lower consumer spending and lower growth. For
example, when prices are falling, consumers are
encouraged to delay purchasing in the hope prices will be
cheaper in the future.
 A moderate inflation rate reduces the real value of debt. If
there is deflation, the real value of debt increases leading to
a squeeze on disposable incomes.
 Moderate rates of inflation allow prices to adjust and goods
to attain their real price.
 Moderat rates of wage inflation, allow relative wages to
adjust. NOminal wages are sticky downwards. WIth
moderate inflation, firms can freeze pay rises for less
productive workers – to effectively give them a real pay cut.
 Moderate rates of inflation are a sign of a healthy economy.
With economic growth, we usually get a degree of inflation.
 See: Advantages of Inflation

Disadvantages of Inflation

Money becomes worthless with very high inflation. Children

playing with worthless German Marks in 1923.

 High inflation rates tend to cause uncertainty and confusion

leading to less investment. It is argued that countries with
 persistently higher inflation, tend to have lower rates of
investment and economic growth.
 Higher inflation leads to lower international
competitiveness, leading to fewer exports and a
deterioration in the current account balance of payments. In
a fixed exchange rate, e.g. the Euro – this is even more
problematic as countries do not have the option of
devaluation.
 Menu costs. – This is the cost of changing price lists.
 Inflation and stagnant wage growth lead to declining
incomes.
 Inflation can reduce the real value of savings, which might
particularly affect old people who live on savings. However,
it does depend on whether interest rates are higher than the
inflation rate.
 Inflation will reduce the real value of government bonds.
Investors will demand higher bond yields to compensate;
this will increase the cost of debt interest payments
 Hyper-inflation can destroy an economy. If inflation gets out
of hand, it can create a vicious cycle, where rising inflation,
causes higher inflation expectations, which in turn pushes
prices even higher. Hyper-inflation can wipe out the savings
of the middle-classes, and redistribute wealth and income
towards those with debt and assets and property.
 Costs of reducing inflation. To restore price stability,
Governments/Central Banks need to pursue deflationary
fiscal/monetary policy. However, this leads to lower
aggregate demand and often a recession. The cost of
reducing inflation – is unemployment, at least in the short-
term.