INFLATION

According to Websters New Universal Unabridged Dictionary published in 1983: An increase in the amount of currency in circulation, resulting in a relatively sharp and sudden fall in its value and rise in prices: it may be caused by an increase in the volume of paper money issued or of gold mined, or a relative increase in expenditures as when the supply of goods fails to meet the demand. This definition includes some of the basic economics of inflation and would seem to indicate that inflation is not defined as the increase in prices but as the increase in the supply of money that causes the increase in prices i.e. inflation is a cause rather than an effect.

The American Heritage Dictionary of the English Language, Fourth Edition says: A persistent increase in the level of consumer prices or a persistent decline in the purchasing power of money, caused by an increase in available currency and credit beyond the proportion of available goods and services. In this definition, inflation would appear to be the consequence or result (rising prices) rather than the cause. Features of inflation are as follows: Inflation is always accompanied by rise in price and it is, in fact, uninterrupted increase in prices. Inflation is essentially an economic phenomenon as it originates within the economic system and is fed by the action and interaction of economic forces. Inflation is a dynamic process which can be observed more or less over a long period. A cyclical movement should not be confused with inflation. Inflation is a monetary phenomenon as it is generally caused by excessive money supply. Pure inflation starts after full-employment.

TYPES OF INFLATION
There are four main types of inflation with four different causes. The most important inflation is called

demand-pull or excess demand inflation. It occurs when the total demand for goods
and services in an economy exceeds the available supply, so the prices for them rise in a market

economy. Historically this has been the most common type and at times the most serious. Every war produces this type of inflation because demand for war materials and manpower grows rapidly without comparable shrinkage elsewhere. Other types of inflation occur more readily in conjunction with demand-pull inflation. Another type of inflation is called cost-push inflation. The name suggests the cause--costs of production rise, for one reason or another, and force up the prices of finished goods and services. Often a rise in wages in excess of any gains in labor productivity is what raises unit costs of production and thus raises prices. This is less common than demand-pull, but can occur independently as well as in conjunction with it. A third type of inflation could be called pricing power inflation, but is more frequently called administered price inflation. It occurs whenever businesses in general decide to boost their prices to increase their profit margins. This does not occur normally in recessions but when the economy is booming and sales are strong. It might be called oligopolistic inflation, because it is oligopolies that have the power to set their own prices and raise them when they decide the time is ripe. One can at such times read in the newspapers that business is just waiting a bit to see how soon they might raise their prices. An oligopolistic firm often realizes that if it raises its prices, the other major firms in the industry will likely see that as a good time to widen their profit margins too without suffering much from price competition from the few other firms in the industry. The fourth type is called sectoral inflation. The term applies whenever any of the other three factors hits a basic industry causing inflation there, and since the industry hit is a major supplier of many other industries, as for example steel is, or oil is, that raises costs of the industries using say steel or oil, and forces up prices there also, so inflation becomes more widespread throughout the economy, although it originated in just one basic sector.

CAUSES OF INFLATION
Long-lasting episodes of high inflation are often the result of relax monetary policy. If the money supply grows too big relative to the size of an economy, the unit value of the currency diminishes; in other words, its purchasing power falls and prices rise. This relationship between the money supply and the size of the economy is called the quantity theory of money, and is one of the oldest hypotheses in economics. Pressures on the supply or demand side of the economy can also be inflationary. Supply shocks that disrupt production, such as natural disasters, or raise production costs, such as high oil prices, can reduce overall supply and lead to cost push inflation, in which the impetus for price increases comes from a disruption to supply. The food and fuel inflation of 2008 was such a case for the global economysharply rising food and fuel prices were transmitted from country to country by trade. Conversely, demand shocks, such as a stock market rally, or expansionary policies, such as when a central bank lowers

interest rates or a government raises spending, can temporarily boost overall demand and economic growth. If, however, this increase in demand exceeds an economys production capacity, the resulting strain on resources is reflected in demand-pull inflation. Policymakers must find the right balance between boosting demand and growth when needed without over stimulating the economy and causing inflation. Expectations also play a key role in determining inflation. If people or firms anticipate higher prices, they build these expectations into wage negotiations and contractual price adjustments (such as automatic rent increases). This behavior partly determines the next periods inflation; once the contracts are exercised and wages or prices rise as agreed, expectations have become self-fulfilling. And to the extent that people base their expectations on the recent past, inflation will follow similar patterns over time, resulting in inflation inertia.

REMEDIES OF INFLATION
Inflation is caused by the failure of aggregate supply to equal the increase in aggregate demand. Inflation can, therefore, be controlled by increasing the supplies and reducing money incomes in order to control aggregate demand. The various methods are usually grouped under three heads: Monetary measures, fiscal measures and other measures.

1. Monetary Measures
Monetary measures aim at reducing money incomes. (a) Credit Control: One of the important monetary measures is monetary policy. The central bank of the country adopts a number of methods to control the quantity and quality of credit. For this purpose, it raises the bank rates, sells securities in the open market, raises the reserve ratio, and adopts a number of selective credit control measures, such as raising margin requirements and regulating consumer credit. Monetary policy may not be effective in controlling inflation, if inflation is due to cost-push factors. Monetary policy can only be helpful in controlling inflation due to demandpull factors. (b) Demonetization of Currency: However, one of the monetary measures is to demonetize currency of higher denominations. Such a measure is usually adopted when there is abundance of black money in the country. (c) Issue of New Currency: The most extreme monetary measure is the issue of new currency in place of the old currency. Under this system, one new note is exchanged for a number of notes of the old currency. The value of bank deposits is also fixed accordingly. Such a measure is adopted when there is an

excessive issue of notes and there is hyperinflation in the country. It is very effective measure. But it is inequitable for its hurts the small depositors the most.

2. Fiscal Measures
Monetary policy alone is incapable of controlling inflation. It should, therefore, be supplemented by fiscal measures. Fiscal measures are highly effective for controlling government expenditure, personal consumption expenditure, and private and public investment. The principal fiscal measures are the following: (a) Reduction in Unnecessary Expenditure. The government should reduce unnecessary expenditure on non-development activities in order to curb inflation. This will also put a check on private expenditure which is dependent upon government demand for goods and services. But it is not easy to cut government expenditure. Though economy measures are always welcome but it becomes difficult to distinguish between essential and non-essential expenditure. Therefore, this measure should be supplemented by taxation. (b) Increase in Taxes. To cut personal consumption expenditure, the rates of personal, corporate and commodity taxes should be raised and even new taxes should be levied, but the rates of taxes should not be so high as to discourage saving, investment and production. Rather, the tax system should provide larger incentives to those who save, invest and produce more. Further, to bring more revenue into the tax-net, the government should penalize the tax evaders by imposing heavy fines. Such measures are bound to be effective in controlling inflation. To increase the supply of goods within the country, the government should reduce import duties and increase export duties. (c) Increase in Savings. Another measure is to increase savings on the part of the people. This will tend to reduce disposable income with the people, and hence personal consumption expenditure. But due to the rising cost of living, people are not in a position to save much voluntarily. Keynes, therefore, advocated compulsory savings or what he called `deferred payment' where the saver gets his money back after some years. For this purpose, the government should float public loans carrying high rates of interest, start saving schemes with prize money, or lottery for long periods, etc. It should also introduce compulsory provident fund, provident fund-cum-pension schemes, etc. compulsorily. All such measures to increase savings are likely to be effective in controlling inflation.

(d) Surplus Budgets. An important measure is to adopt anti-inflationary budgetary policy. For this purpose, the government should give up deficit financing and instead have surplus budgets. It means, collecting more in revenues and spending less. (e) Public Debt. At the same time, it should stop repayment of public debt and postpone it to some future date till inflationary pressures are controlled within the economy. Instead, the government should borrow more to reduce money supply with the public. Like the monetary measures, fiscal measures alone cannot help in controlling inflation. They should be supplemented by monetary, non-monetary and non fiscal measures.

3. Other Measures
The other types of measures are those which aim at increasing aggregate supply and reducing aggregate demand directly. (a) To Increase Production: The following measures should be adopted to increase production: (i) One of the foremost measures to control inflation is to increase the production of essential consumer goods like food, clothing, kerosene oil, sugar, vegetable oils, etc. If there is need, raw materials for such products may be imported on preferential basis to increase the production of essential commodities. Efforts should also be made to increase productivity. For this purpose, industrial peace should be maintained through agreements with trade unions, binding them not to resort to strikes for some time. The policy of rationalization of industries should be adopted as a long-term measure. Rationalization increases productivity and production of industries through the use of brain, brawn and bullion. All possible help in the form of latest technology, raw materials, financial help, subsidies, etc. should be provided to different consumer goods sectors to increase production.

(ii)

(iii)

(iv)

(v)

(b) Rational Wage Policy. Another important measure is to adopt a rational wage and income policy. Under hyperinflation, there is a wage-price spiral. To control this, the government should freeze wages, incomes, profits, dividends, bonus, etc. But such a drastic measure can only be adopted for a short period and by antagonizing both workers and industrialists. Therefore, the best course is to link increase in wages to increase in productivity. This will have a dual effect. It will control wage and at the same time increase productivity, and hence production of goods in the economy. (c) Price Control. Price control and rationing is another measure of direct control to check inflation. Price control means fixing an upper limit for the prices of essential consumer goods. They are the maximum prices fixed by law and anybody charging more than these prices is punished by law. But it is difficult to administer price control. (d) Rationing. Rationing aims at distributing consumption of scarce goods so as to make them available to a large number of consumers. It is applied to essential consumer goods such as wheat, rice, sugar, kerosene oil, etc. It is meant to stabilize the prices of necessaries and assure distributive justice. But it is very inconvenient for consumers because it leads to queues, artificial shortages, corruption and black marketing. Keynes did not favor rationing for it "involves a great deal of waste, both of resources and of employment."

3 main ways by which inflation can be controlled: 1. Adopt tight monetary policy undertaken by Central Bank that uses some instruments to influence the economy by reducing money supply and higher interest rates.

2. contractionary fiscal policy that deals with reducing government expenditures and increasing tax . 3. Direct control - direct govt intervention in the price mechanism of the country. To be effective all 3 methods, i.e. monetary policy, fiscal policy and direct control must be implemented simultaneously. Price pegging Government fixed the floor and ceiling prices , so that prices will not increase rapidly Producers will not be able to increase prices according to their own wishes.

Control of trade union Demand for higher wages has caused cost-push inflation Persuade not to make these demands.

Anti-hoarding campaign Done in Asian countries, where reports were made against producers and consumers who store their goods unnecessarily because such storage could cause artificial shortage and push prices up. Price tagging Prices of all goods have to be labelled. Prevent producers from over-charging the consumers.

Conclusion:
From the various monetary, fiscal and other measures discussed above, it becomes clear that to control inflation, the government should adopt all measures simultaneously. Inflation is like a hydra-headed monster which should be fought by using all the weapons at the command of the government.

Difference between inflation, deflation and stagflation:

Over the course of many years economic cycles go through periods of inflation, deflation and stagflation. Each one of these has a specific effect on the overall economy as a whole and sometimes can lead to long periods of recessions or depressions in the economy.

Inflation
Inflation could be monetary or price inflation. During periods of inflation there is an increase of the money supply. When you have inflation more money being circulated which causes the currency to lose its purchasing power which leads to an increase in the price of goods and services.

Deflation
When in times of deflation we typically see the falling of prices. This is generally caused by credit or money supplies being contracted. A reduction in government or consumer spending could also be a cause of deflation which often leads to an increase in unemployment.

Stagflation
When you have a slow economy with high inflation rates and unemployment, stagflation is usually the result. When the economy does not grow and prices continue to rise you have a stagflation cycle in the economy.

Difference between Devaluation and Depreciation of money:

Depreciation
A decrease in the value of a currency with respect to other currencies. This means that the depreciated currency is worth fewer units of some other currency. While depreciation means a reduction in value, it can be advantageous as it makes exports in the depreciated currency less expensive.

Devaluation
Devaluation/revaluation refers to a change in the relative value of a currency as a result of deliberate government decision to change the value of the currency under a fixed exchange rate regime.

For example, suppose one unit of Currency A is Examples of devaluation are not as common as worth one unit of Currency B. If Currency A depreciation. depreciates such that it becomes worth half of one unite of Currency B, then exports denominated in Currency A are only half as expensive when trading in a Currency B market