Inflation

Inflation in economics is defined as the persistent increase in the price level of goods and services and the decline in purchasing power within an economy over time. When the rise in prices exceeds the rise in output, the situation is termed an inflationary situation. Inflation can occur due to various reasons, with one major cause being a rapid increase in the money supply, which leads to a decrease in interest rates.

Theories of Inflation

Samuelson-Nordhaus - “Inflation is a rise in the general level of prices.”

Coulborn - Inflation can be defined as “too much money chasing too few goods.”

Johnson - “Inflation is an increase in the quantity of money faster than real national output is expanding.”

Parkin and Bade - “Inflation is an upward movement in the average level of prices. Its opposite is deflation, a downward movement in the average level of prices. The boundary between inflation and deflation is price stability.”

Peterson - “The word inflation in the broadest possible sense refers to any increase in the general price level which is sustained and non-seasonal in character.”

Types of Inflation

Inflation varies in nature and causes, requiring differentiation among its types. Recognizing these distinctions is essential for analyzing its effects and recommending effective anti-inflationary policies. There are 8 major types of inflation :

• Moderate inflation
• Galloping inflation
• Hyperinflation
• Demand-pull Inflation
• Cost-push Inflation
• Structural Inflation
• Walking/Trotting Inflation
• Stagflation

Moderate Inflation

Moderate inflation, also referred to as creeping inflation, occurs when the prices of goods and services rise steadily at a single-digit rate annually. During periods of moderate inflation, prices increase at a relatively slow and predictable rate, varying between countries. This predictability allows individuals to retain money as a store of value without fear of drastic erosion in purchasing power.

Galloping Inflation

Galloping inflation occurs when prices rise at an exceptionally high rate, typically in the range of two-digit or three-digit figures annually. Also known as jumping inflation, it severely impacts middle- and lower-income groups, leaving them unable to save for the future. In such situations, stringent measures are necessary to control inflation.

For example, the United States experienced galloping inflation during the 1970s due to the OPEC oil embargo and the Vietnam War.

Hyperinflation

Hyperinflation represents an extreme and uncontrollable escalation in prices, often exceeding three-digit rates annually. It arises from an unchecked increase in the money supply, disrupting the balance between money demand and supply. As a result, the currency rapidly loses its real value.

A historical example is the hyperinflation in Germany in 1923, where prices doubled every two days, rendering the German mark worthless.

Demand-Pull Inflation

Demand-pull inflation occurs when the demand for goods and services exceeds their supply, driving prices upward. For instance, a sudden surge in demand for housing can lead to an increase in home prices.

Cost-Push Inflation

Cost-push inflation is driven by rising production costs, which are transferred to consumers as higher prices. This can be caused by factors such as increasing raw material costs or wages. For example, if the price of a critical input like crude oil rises, the cost of related goods and services also increases.

Structural Inflation

Structural inflation results from imbalances within the supply chain or production process, causing sustained price increases. For example, a shortage of crude oil can drive up prices, affecting various industries dependent on it.

Walking/Trotting Inflation

Walking inflation, also called trotting inflation, refers to a gradual and steady rise in prices, typically associated with a growing economy. This type of inflation is generally not a cause for concern and reflects economic stability. For example, the United States experienced walking inflation during the 1990s, a period of steady economic growth.

Stagflation

Stagflation is a unique situation where high inflation coincides with high unemployment and stagnant economic growth. This combination poses significant challenges for policymakers. A notable example is the stagflation in the United States during the 1970s, caused by soaring oil prices and rising unemployment.

Inflation Causes

Inflation can primarily result from three key causes: demand-pull inflation, cost-push inflation, and built-in inflation.

Demand Pull Inflation

Demand-pull inflation arises when aggregate demand in an economy exceeds aggregate supply. It occurs as real GDP rises and unemployment falls, commonly referred to as “too much money chasing too few goods.” This type of inflation may stem from factors such as excessive investment or consumption, low-cost loans, tax reductions, or increased government spending.

Cost Push Inflation

Cost-push inflation occurs when significant increases in production costs, such as raw materials or wages, lead businesses to pass these costs on to consumers in the form of higher prices. Imperfect competition, increased taxes, or political incidents, like oil crises, can trigger this type of inflation.

Built In Inflation

Built-in inflation is induced by adaptive expectations and is often linked to the wage-price spiral. Workers demand higher wages to match rising prices, and employers pass on these increased costs to consumers, creating a cycle. This type of inflation is often seen as a legacy of past economic conditions and may persist as “hangover inflation.”

Effects of Inflation

Inflation has significant effects on income redistribution, societal well-being, and economic balance.

Redistribution effect of inflation

Inflation disproportionately affects individuals with fixed incomes, as their nominal income remains constant while its real value declines. It erodes the purchasing power of wages that fail to keep pace with price increases and diminishes the value of loans and savings.

Social impact of inflation

Inflation aggravates inequality, as poorer individuals are more vulnerable to rising prices than wealthier ones. This often leads to social unrest and dissatisfaction among the affected groups.

Impact on economy balance

Inflation can reduce real output below its potential, distort consumption patterns as consumers shift to cheaper goods, and increase export competitiveness under a fixed exchange rate. However, it also deforms prices, raises costs, and makes the economy less efficient. While creeping or anticipated inflation can stimulate growth, unanticipated or high inflation presents serious economic challenges.

Inflation Control

Some of the important measures to control inflation are as follows:

• Monetary Measures
• Fiscal Measures
• Other Measures

Monetary Measures

Monetary measures aim at reducing money incomes.

• 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 demand-pull factors.

• Demonetisation of Currency: However, one of the monetary measures is to demonetise currency of higher denominations. Such a measures is usually adopted when there is abundance of black money in the country.

• 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 a very effective measure. But is inequitable for its hurts the small depositors the most.

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:

• 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 this measure is always welcome but it becomes difficult to distinguish between essential and non-essential expenditure. Therefore, this measure should be supplemented by taxation.

• 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.

• 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.

• 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.

Other Measures

The other types of measures are those which aim at increasing aggregate supply and reducing aggregate demand directly.

To Increase Production: The following measures should be adopted to increase production:

• 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 rationalisation of industries should be adopted as a long-term measure. Rationalisation 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.

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.

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.

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 stabilise the prices of necessaries and assure distributive justice.