Download Inflation Features

INFLATION:
Inflation means a considerable and persistent rise in the general level of prices over a long
period of time.
Definition
According to Webster’s New Universal Unabridged Dictionary,
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.
According to Crowther,
“Inflation is a state in which the value of money is failing i.e. the prices is rising.”

Features of Inflation
The characteristics or features of inflation are as follows:1. Inflation involves a process of the persistent rise in prices. It involves rising trend in price
level.
2. It is a state of disequilibrium.
3. It is scarcity oriented.
4. It is dynamic in nature.
5. Inflationary price rise is persistent and irreversible.
6. Inflation is caused by excess demand in relation to supply of all types of goods and
services.
7. It is a purely monetary phenomenon.
8. It is a post full employment phenomenon.
9. It is a long-term process.

Types of inflation:
(1) On the Basis of Rate of Inflation:
Inflation on this basis is grouped as (i) Creeping inflation (ii) Walking inflation (iii) Running
inflation and (iv) Hyper 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 rises up to a rate of 2 percent 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 percent annually.
(iii) Running inflation.
Under running inflation, the price increase is about 8 to 10 percent 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.
(2) On the Basis of Degree of Control:
On the basis of degree of control over the rise in price level, the inflation can be identified
as (i) Open Inflation (ii) Suppressed Inflation
(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 control and rationing.
When the price level is suppressed by the above short term measures, it results in many
evils such black marketing, hoarding, corruption and profiteering.
(3) Inflation on the Basis of Causes:
Inflation on the basis of causes is classified as under:
(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.va of the currency, higher mark up etc., etc.
(iii) Profit Induced Inflation.
Profit inflation is in fact categorized under cost push inflation. When entrepreneurs, 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 covers the deficits in the budgets through bank
borrowings. And creating new money (Deficit financing), the purchasing power of the community
increases without a simultaneous increase in the production of goods. This leads to rise in the
general
price
level.
(v) Monetary inflation:
Milton Firedman 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 casual, therefore, a
variety
of
policy
measures
are
needed
to
deal
with
it.
(4) On the Basis of Employment.

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.

Full inflation
Full inflation prevails when the economy has reached t level of full employment. Any
increase in money supply beyond full employment level will result in the rise in price level without
any increase in output and employment. It is also called as real inflation.
(5)
Anticipated
versus
unanticipated
inflation:
(i) Anticipated inflation is the rate of inflation which majority of the individuals believes will
occur. When the rate of inflation (say 6%) turns out to be the same (6%), we are then in a
situation
of
fully
anticipated
inflation.
(ii) Unanticipated inflation is that which comes as surprise to majority of individuals. It can be
higher or lower than the rate of anticipated inflation.
 Causes of inflation
Inflation is caused when the aggregate demand exceeds the aggregate supply of goods and
services. We analyze the factors which lead to increase in demand and the shortage of supply.

Factors Affecting Demand
Both Keynesians and monetarists believe that inflation is caused by increase in the
aggregate demand. They point towards the following factors which raise it.
1.
Increase in money supply:
Inflation is caused by an increase in the supply of money which leads to increase in
aggregate demand. The higher the growth rate of the nominal money supply, the higher is the
rate of inflation. Modern quantity theorists do no believe that. True inflation starts after the full
employment level. This view is realistic because all advanced countries are faced with high
levels of unemployment and high rates of inflation.
2.
Increase in disposable income:
When the disposable income of the people increases, it raises their demand for goods
and services. Disposable income may increase with the rise in national income or reduction
in taxes or reduction in the saving of the people.
3. Increase in public expenditure:
Government activities have been expanding much with the result that government
expenditure has also been increasing at a phenomenal rate, thereby raising aggregate
demand for goods and services. Governments of both developed and developing countries
are providing more facilities under public utilities and social services, and also nationalizing
industries and starting public enterprises with the result they help in increasing aggregate
demand.
4. increase in consumer spending:
The demand for goods and services increases when consumer expenditure increases.
Consumers may spend more due to conspicuous consumption or demonstration effect. They
may also spend more when they are given credit facilities to buy goods on hire-purchase and
installment basis.
5. Cheap Monetary Policy:
Cheap monetary policy or the policy of credit expansion also leads to increase in the
money supply which raises the demand for goods and services in the economy. When credit
expands, it raises the money income of the borrowers which, in turn, raises aggregate
demand relative to supply, herby leading to inflation. This is also known as credit-induced
inflation.
6. deficit financing:
In order to meet its mounting expenses, the government resorts to deficit financing by
borrowing from the public and even by printing more notes. This raises aggregate demand in
relation to aggregate supply, thereby leading to inflationary rise in prices. This is also known
as deficit-induced inflation.
7. expansion of the private sector:
The expansion of the private sector also tends to raise the aggregate demand. For huge
investments increase employment arid income, thereby creating more demand far goods and
services. But it takes time for the output to enter the market.
8. black money:
The existence of black money in all countries due to corruption, tax evasion etc. increase
the aggregate demand. People spend such unearned money extravagantly, thereby creating
unnecessary demand for commodities. This tends to raise the price level further.
9. repayment of public debt:
Whenever the government repays its past internal debt to the public, it leads to increase
in the money supply with the public. This tends to raise the aggregate demand for goods and
services.
10. increase in exports:
When the demand for domestically produced goods increases in foreign countries, this
raises the earnings of industries producing export commodities. These, in turn, create more
demand for goods and services within the economy.

Factors affecting supply:
1. Shortage of factors of production:
one of the important causes affecting the supplies of goods is the shortage of such
factors as labour, raw materials, power supply, capital etc. they lead to excess capacity and
reduction in industrial production.
2. Industrial dispute:
In countries where trade unions are powerful, they also help in curtailing production.
Trade unions resort to strikes and if they happen to be unreasonable from the employers’
viewpoint and are prolonged, they force the employers to declare lock-outs. In both cases,
industrial production falls, thereby reducing supplies of goods. If the unions succeed in rising
money wages of their members to a very high level than the productivity of labour, this also
tends to reduce production and supplies of goods.
3. Natural calamities:
Drought or floods is a factor which adversely affects the supplies of agricultural products.
The latter, in turn, create shortages of food products and raw materials, thereby helping
inflationary pressures.
4. Artificial scarcities:
Artificial scarcities are created by hoarders and speculators who indulge in black marketing.
Thus they are instrumental in reducing supplies of goods and raising their prices.
5. Increase in exports:
When the country produces more goods for export than for domestic consumption, this
creates shortages of goods in the domestic market. This leads to inflation in the economy.
6. Lop- sided production:
If the stress is on the production of comfort, luxuries, or basic products to the neglect of
essential consumer goods in the country, this creates shortages of consumer goods. This again
causes inflation.
7. Law of diminishing returns:
If industries in the country are using old machines and outmoded methods of production, the
law of diminishing returns operates. This raises cost per unit of production, thereby raising the
prices or products.
8. International factors;
In modern times, inflation is a worldwide phenomenon. When prices rise in major industrial
countries, their effects spread to almost all countries with which they have trade relations. Often
the rise in the price of a basic raw material like petrol in the international market leads to rise in
the price of all related commodities in a country.

Effects of inflation
Most effects of inflation are negative, and can hurt individuals and companies alike, below is
a list of negative and “positive” effects of inflation:
Negative effects are:
1. Hoarding (people will try to get rid of cash before it is devalued, by hoarding food and
other commodities creating shortages of the hoarded objects).
2. Distortion of relative prices (usually the prices of goods go higher, especially the prices of
commodities).
3. Increased risk - Higher uncertainties (uncertainties in business always exist, but with
inflation risks are very high, because of the instability of prices).
4. Income diffusion effect (which is basically an operation of income redistribution).
5. Existing creditors will be hurt (because the value of the money they will receive from their
borrowers later will be lower than the money they gave before).
6. Fixed income recipients will be hurt (because while inflation increases, their income
doesn’t increase, and therefore their income will have less value over time).
7. Increased consumption ratio at the early stages of inflation (people will be consuming
more because money is more abundant and its value is not lowered yet).
8. Lowers national saving (when there is a high inflation, saving money would mean
watching your cash decrease in value day after day, so people tend to spend the cash on
something else).
9. Illusions of making profits (companies will think they were making profits while in reality
they’re losing money if they don’t take into consideration the inflation rate when
calculating profits).
10. Causes an increase in tax bracket (people will be taxed a higher percentage if their
income increases following an inflation increase).
11. Causes mal-investment (in inflation times, the data given about an investment is often
deceptive and unreliable, therefore causing losses in investments).
12. Causes business cycles (many companies will have to go out of business because of the
losses they incurred from inflation and its effects).
13. Currency debasement (which lowers the value of a currency, and sometimes cause a
new currency to be born)
14. Rising prices of imports (if the currency is debased, then its purchasing power in the
international market is lower).
"Positive" effects of inflation are:
1. It can benefit the inflators (those responsible for the inflation)
2. It is benefit early and first recipients of the inflated money (because the negative effects
of inflation are not there yet).
3. It can benefit the cartels (it benefits big cartels, destroys small sellers, and can cause
price control set by the cartels for their own benefits).
4. It might relatively benefit borrowers who will have to pay the same amount of money they
borrowed (+ fixed interests), but the inflation could be higher than the interests; therefore
they will be paying less money back. (example, you borrowed $1000 in 2005 with a 5%
fixed interest rate and you paid it back in full in 2007, let’s suppose the inflation rate for
2005, 2006 and 2007 has been 15%, you were charged %5 of interests, but in reality,
you were earning %10 of interests, because 15% (inflation rate) – 5% (interests) = %10
profit, which means you have paid only 70% of the real value in the 3 years.
Note: Banks are aware of this problem, and when inflation rises, their interest rates might
rise as well. So don't take out loans based on this information.
5. Many economists favor a low steady rate of inflation, low (as opposed to zero or
negative) inflation may reduce the severity of economic recessions by enabling the labor
market to adjust more quickly in a downturn, and reducing the risk that a liquidity trap
prevents monetary policy from stabilizing the economy. 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 the size of the money supply
through the setting of interest rates, through open market operations, and through the
setting of banking reserve requirements.
6. Tobin effect argues that: a moderate level of inflation can increase investment in an
economy leading to faster growth or at least higher steady state level of income. This is
due to the fact that inflation lowers the return on monetary assets relative to real assets,
such as physical capital. To avoid inflation, investors would switch from holding their
assets as money (or a similar, susceptible to inflation, form) to investing in real capital
projects.