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When the prices of most goods and services are rising over time, the economy is said to be experiencing

inflation. The word inflation refers to a general rise in prices measured against a standard level of purchasing power Definition
1. 2. 3. 4.

Harry Johnson defines inflation as a sustained rise in prices. According to Coulborn, Inflation is a situation of too much money chasing too few goods. Inflation is a state in which the value of money is falling i.e., prices are rising Crowther According to Prof. Samuelson, Inflation occurs when the general level of prices and cost is rising.

Two distinct view of inflation A pure monetary phenomenon When money supply exceeds the normal absorbing capacity of the economy it leads to persistently rising prices. A post-full employment phenomenon A consortium (group) of economists including Pigou or Keynes gave importance to this view Four terms are related to the concept of inflation relating to post full employment phenomenon Reflation It is the situation of rising prices deliberately undertaken to relieve a depression. With rising prices, employment, output; the income also increases till the economy reaches the full employment ceiling. Inflation It occurs when prices rise after the stage of full employment is reached in the economy with no corresponding rise in employment and output. Disflation When prices are falling due to anti-inflationary measures adopted by the authorities with no corresponding decline in the existing level of employment, output and income Deflation It is a condition of falling prices accompanied by a decreasing level of employment, output and income. It is just the opposite of inflation. Each and every fall in price cannot be called deflation. The process of reversing inflation without either creating unemployment or reducing output is called disinflation but not deflation. TYPES OF INFLATION I. On the basis of speed
1. 2. 3.

Moderate inflation Running inflation & Galloping inflation Hyper inflation

II. On the basis of money quantity


1.

Excessive money supply inflation

2. 3. 4.

Cost inflation Deficit inflation Flight inflation

III. On the basis of time


1. 2. 3.

War-time inflation Post-war inflation Peace-time inflation

IV. On the basis of coverage or scope

1. 2.

Comprehensive inflation Sporadic inflation

V. On the basis of government intervention


1. 2.

Open inflation Repressed inflation

VI. Other Inflation


1.

Profit inflation

I. On the basis of speed 1. Moderate inflation It is also known as creeping inflation. It is a tolerable form of inflation. It occurs when prices are rising slowly when the rate of inflation is less than 10% annually or it is a single digit annual inflation rate. 2. Running inflation & Galloping inflation When the movement of price accelerates rapidly, running inflation emerges. Running inflation may record more than 100% rise in prices over a decade (10 years). Economists have not described the range of running inflation but we may say that a double digit inflation of 10 to 20% per annum is a running inflation. If it exceeds that figure it may be called galloping inflation. According to Samuelson, when prices are rising at double or triple digit rates of 20, 100 or 200% a year, the situation may be described as galloping inflation. Indian economy has witnessed a sort of running and galloping inflation to some extent (not exceeding 25% p.a) during the planning era, since the second plan period. Argentina, Brazil, Israel for instance have experienced inflation rates over 100% in 80s. 3. Hyper inflation In the case of hyper inflation prices rise every moment and there is no limit to the height to which prices might rise. Therefore it is difficult to measure its magnitude, as prices rise continuously. In quantitative terms when prices rise over 100% in a year it is called a hyper inflation. Austria, Hungary, Germany, Poland and Russia witnessed (seen, observed) hyper inflation in the wake of World War I. II. On the basis of money quantity

1. Excessive money supply inflation This is the classical type if inflation, where there is an excess of money supply in relation to the availability of real goods and services. This type of inflation is usually conceived of as cyclical fluctuations in the economy. 2. Cost inflation When inflation emerges on account of a rise in factor cost it is called cost inflation. It occurs when money income (wage rate particularly) expand more than real productivity due to a rising cost of living index, workers demand higher wages, and higher wages in turn increases the cost of production, which a producer generally meets by raising prices. This process of spiraling (rising, increasing) rise may reach higher and higher levels. 3. Deficit inflation When the government budgets contain heavy deficit financing, through creating new money, the purchasing power in the community increases and prices rise. This may also be referred as deficit induced inflation. 4. Flight inflation This type of inflation refers to the relationship between money supply and goods where there is a flight of currency, reflecting increased velocity of spending. This is the result of peoples psychological reactions when they find an intolerable decline in the value of money. It has been said that this stage is always reached by recurring budget deficits and the creation of new money under deficit financing. III. On the basis of time 1. War-time inflation It is the outcome of certain emergencies of war on account of increased government expenditure on defense which is of an unproductive nature. By such public expenditure the government apportions (share) a substantial production of goods and services out of total availability for war which causes a downward shift in the supply, a result an inflationary gap may develop. 2. Post-war inflation In the immediate post-war period it is usually experienced this may happen when the disposable income of the community increases when war time taxation is withdrawn. 3. Peace-time inflation By this it is meant that the rise in prices during the normal period of peace. Peace-time inflation is often a result of increased government outlays on capital projects having a long gestation period (time taken to produce the product). So a gap between money income and real wage goods develops. IV. On the basis of coverage or scope 1. Comprehensive inflation When prices of every commodity throughout the economy rise it is called economy wide or comprehensive inflation. It is a normal inflationary phenomenon and refers to a rise in the general price level 2. Sporadic inflation This is a kind of sectional inflation. It consists of cases in which the averages of a group of prices rise because of increases in individual prices due to abnormal shortage of specific goods. E.g. during drought conditions when there is a failure of crops food grains prices shot up. V On the basis of government intervention

Inflation is open or repressed according to the governments reaction to prevalence of inflationary forces in the economy. 1. Open inflation When the government does not attempt to prevent a price rise, inflation is said to be open. Thus inflation is open when prices rise without any interruption. The post-war hyper inflation during the 1920s in Germany is a living example of open inflation. 2. Repressed inflation When the government interrupts the price rise, there is repressed or suppressed inflation. Thus, suppressed inflation refers to those conditions in which price increases are prevented at the present time through adoption of certain measures like principal controls and rationing by the government; but they rise on the removal; of such controls and rationing. VI. Other Inflation 1. Profit inflation The concept of profit inflation was originated by Keynes in his Treaties on Money. According to Keynes, the price level of consumption goods is a function of investment exceeding savings the considered the investment boom. So the imbalances between money income and real income are corrected through rising prices. CAUSES OF INFLATION Demand Pull Inflation Cost Push Inflation OTHER CAUSES OF INFLATION 1. Demand side a) Money Supply b) Disposable income c) Consumer expenditure and business outlay d) Foreign demand 2. Supply side a) Full Employment b) Shortages c) Diminishing returns d) Export induced scarcity e) Wage price increase CAUSES OF INFLATION Demand Pull Inflation According to demand pull theory prices rise in response to an excess of total demand over existing supply of goods and services. The demand pull theorists point out that inflation (demand pull) might be caused in the first place

by an increase in the quantity of money, when the economy is operating at full employment level. As the quantity of money increases the rate of interest will fall and consequently investment will increase. This increased investment expenditure will soon increase the income of various factors of production as a result aggregate consumption expenditure will increase, leading to an increase in effective demand. With the economy already operating at the level of full employment this will immediately rise prices there by generating inflationary forces. Thus when the general monetary demand rises faster than the general supply, it pulls up prices. However, the demand pull inflation can also occur without an increase in the money supply this can happen when the marginal propensity to consume rises. So that investment expenditures may rise thereby leading to a rise in the aggregate demand which will exert (use, apply, exercise) its influence in raising prices beyond the level of full employment already attained in the economy. Cost Push Inflation A group of economists, hold the opposite view that the process of inflation is initiated not by an excess of general demand but by an increase in cost, as factors of production try to increase their market share of total product by raising their prices. Thus it has been seen that a rise in prices is initiated by the growing factor costs. Therefore, such a price rise is termed as cost push inflation. As prices are being pushed up by the raising factor cost. OTHER CAUSES OF INFLATION 1. Demand side a) Money Supply Inflation is directly link to the changes in the money supply. An increase in money supply increases money income thereby causing the monetary demand for goods and services to rise. Money supply can increase in following way y Deficit financing (printing more paper notes) to deal with the difference between government expenditure and government revenue. b) Disposable income When the net disposable money income of people increases monetary demand for real goods and services rise. c) Consumer expenditure and business outlay The consumers rate of spending can increase in the following ways: y Disposable income increases consumer expenditure also increase y By a reduction in current savings y By the use of accumulated savings y The possession of liquid assets such as bonds and securities which are readily encashable y With the extension of consumers credit such as hire or installment purchase schemes. An increase in business outlay refers to the increase in investment expenditure by the business community. It expresses an increase in the monetary demand for capital goods, raw material and factors of production. d) Foreign demand An additional factor in the increased monetary demand is foreign expenditure for domestic goods and services. 2. Supply side

a) Full Employment When the full employment stage is reached by the economy b) Shortages When there is a shortage and deficiency of factors of production, shortage of land, labour, capital equipments, raw materials, etc. c) Diminishing returns Operation of the law of diminishing returns in variable factors with a given technological structure also causes slow movement of supply of real goods and services. d) Export induced scarcity Increasing the export of certain goods which have a strong domestic demand evidently aggravates (influences) the supply situation. e) Wage price increase When wages rise the cost of production also rise. Thus entrepreneurs usually adjust cost increases by increasing prices rather than by absorbing them, fully or partly by reducing profits. EFFECTS OF INFLATION 1) Effects on production 2) Effects on distribution (income distribution) 3) Effect on consumption and welfare 4) Social and political effect 1) Effects on production According to Keynes a moderate rise in prices that is a mild inflation or creeping inflation as a favourable effect on production when there are unutilized or underemployed resources in existence in an economy. Rising prices leads to optimistic expectations within the business community in view of increasing profit margins, because the price level moves up at a faster rate than the cost of production. Businesses are induced to invest more and as a result employment, output and income increase. The tempo (pace) of economic activity start rising but there is a limit to it; this limit is set by the full employment ceiling. The benefit on production however is possible only when inflation does not take place at too faster rate. 2) Effects on distribution (income distribution) Inflation redistributes income, because prices of all factors do not rise in the same proportion. Since the effect of inflation on the incomes of different classes of earners varies there are serious social consequences. All producers, traders and speculators gain during inflation because of the windfall profits which arise because prices rise at a faster rate than the cost of production; wages, interest and rent do not increase rapidly. i) Debtors and creditors Debtors generally gain and creditors loose during an inflation. Gain accrues to a debtor because he repays loan at a time when the purchasing power of money is lower than when it was borrowed. The creditor on the other hand is a looser during inflation since he receives in effect less in goods and services than he would have received in the times of low prices. ii) Business community Inflation is welcome by entrepreneurs and businessmen because they stand to profit by raising prices. They find that the value of their inventories and stock of goods is rising in money terms. They also find that the prices are rising faster than the cost of production, so that their profit margin is greatly enhanced. iii) Fixed income groups Inflation hits wage earners and salaried people very hard. Although wage earners by the grace of trade unions can chase increasing prices, they rarely win the race since wages do not rise at the same rate and at the same time as the general price level, the cost of living rises and the real income of wage earners

decreases. Those who depend exclusively on fixed salaries for a living are severely affected by inflation. Among these people are government servants, clerks, pensioners and persons living on past savings. iv) Investors Those who invest in debentures and fixed interest bearing securities, bonds, etc. lose during inflation. However, investors in equities (stocks) benefits because more dividend is earned on account of high profits made by joint stock companies during inflation. v) Farmers Farmers usually gain during inflation because they can get better prices for their harvest during inflation. 3) Effect on consumption and welfare It is a form of taxation which decreases the consumers money value, due to deteriorating (weakening,) purchasing power the real consumption of the common people declines. Rising cost of living during inflation implies falling standard of living and lowering of general economic welfare of the community at large. A galloping inflation is therefore described as the cruelest tax of all. 4) Social and political effect Continuous inflation in a country creates social and political problems. Inflation redistributes income and wealth in favour of the rich and widens the gap of inequality thereby aggravating social injustice. On the political front inflation is a manifestation (sign, symptom) of the weakness in political discipline. The increasing grievances and the hardships of the masses in general on account of inflation may prepare them to revolt against society and the state. Inflation not only disrupts the economy but also prepares the ground for social and political problems. HOW TO CONTROL INFLATION 1) Cut down expenditure 2) Increase taxes so as to force the paying people to curb (control) expenditure and through tax incentives encourage people to save more 3) Tighten money supply and make credit more difficult and expensive for business people 4) Improved wage and price controls 5) Devaluate the currency so as to make the currency more competitive thereby encourage exports and restrict imports by making them more expensive. WHAT GOVERNMENT DOES TO CONTROL INFLATION? a) Curbing excessive demand y Reduction of non-development government expenditure y Limiting the amount of deficit financing y Monitoring money supply b) Increase in supply of goods y Increase in agriculture and industrial product y Import of essential goods like food-grains, edible oils, etc. c) Public distribution of goods

y Opening of fair price shops for distribution of food grains, sugar, etc., and fix prices and quantities y Maintenance of buffer (extra) stock through procurement. y Legislation to regulate the sale of price of various goods

METHODS OF CONTROLLING INFLATION Broadly speaking anti inflationary measures can be classified as under 1) Monetary Measures 2) Fiscal Measures 3) Non Monetary Measures 1) Monetary Measures The best remedy for fighting inflation is to reduce the aggregate (total, combine) spending. Monetary policy can help in reducing the pressure of demand. Monetary policy works by controlling the cost and availability of credit. During inflation, the central bank can raise the cost of borrowing and reduce the credit creating capacity of the commercial banks. This will make borrowing more costly than before and thereby the demand for funds will be reduced. Similarly, with a reduction in the credit creating capacity, the banks will be more cautious in their lending policies. The result will be a fall in the volume of spending. a) Raising bank rate The bank rate is a rate at which the central bank is willing to rediscount eligible paper offered by the commercial banks. i. Borrowing becomes more costly than before ii. An increase in the rate of interest has some adverse psychological effects on the enthusiasm of business men for additional spending on investment. iii. An increase in the rate of interest may make saving more attractive than before so that some people will be tempted to consume less of their income than before. This will reduce consumers spending. b) Directly controlling credit creation This method is used to cut directly the credit creating capacity of banks. If the central bank of the country can reduce the cash availabl e to the banking system, the capacity of banks to lend money to the borrowers will be reduced. The borrowers now not being able to get help from the banks as easily as previously will be forced to postpone their investment plans. The various methods of controlling the credit creating capacity of banks are i. Open market operations If the central bank wants to reduce the credit creating capacity of commercial banks, it will sell government securities to the public or to the banks themselves. The result will be that the amount of cash with the banks will diminish and this will force them to reduce the supply of credit. ii. Varying reserve ratios The banks are required to keep certain minimum cash in relation to the volume of their deposits and the central banks has the power to change these ratios from time to time. When it desires to reduce the credit created by commercial banks, the cash ratios can be raised so that for a given amount of deposits banks now need to keep higher cash reserve than before. This will exercise the contractional effect on bank credit. Thus monetary measures consist on fixing

a. Higher discount rate b. Higher reserve requirement c. Open market operations d. Selective credit controls or regulations of consumer credit and varying margin requirements. 2) Fiscal Measures The two wings of fiscal policy are government revenues and government expenditures. The government fiscal policy can contribute to the control of inflation either by reducing private spending by increasing the taxes on private sector or by decreasing government expenditure, or by combining both the elements. If private spending tends to be excessive; the government can moderate the inflationary pressure by reducing its own expenditure. But reduction or postponement of government expenditure in modern times is not an easy task. There may be projects already under construction and these obviously cannot be postponed. Similarly the other types of expenditures may be necessary to meet the normal requirement of the collective consumption of the community (defense, police, justice, etc.). Then there may be social expenditure on education, health etc, which are very difficult to cut because of undesirable political effects. Therefore, the major emphasis of fiscal policy in inflation has been on reducing private spending through increased taxation. An increase in taxes tends (likely) to reduce private spending. If the rates of direct taxes on income or profits are raised, the private disposable income is reduced and this will tend to reduce private consumption spending. Thus, in periods of inflation the government should curb (control) its own spending and increase the tax rate to reduce private spending. 3) Non monetary measures Apart from monetary and fiscal measures, it becomes necessary also to resort to some measures of non-monetary nature. These nonmonetary measures include. y Increasing outputs or increasing inputs and decreasing exports. So as to increase the available supply if goods in short supply y Controlling money wages to keep down costs y Price controlling