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Inflation
Meaning of Inflation
• A sustained rise in the general price level over a period of
time is known as inflation.
• Conversely, a sustained fall in the general price level
would be known as deflation.
• Inflation is measured in terms of a price index.
• For instance in India, we have the wholesale price index
(WPI) and the consumer price index (CPI).
• The Price Index is based on a basket of goods and services.
• Within a given basket, the prices of some goods and
services may rise or fall.
Contd.
• Inflation is a rate of change in the price level.
• The rate of change is measured with reference to the base
year so that a long term perspective is obtained with regard
to price rise.
• For all practical purposes, inflation rate is measured on
yearly basis.
• However, in recent years ,the inflation rate is also
measured on monthly or weekly basis.
• The rate of inflation can be measured as: P= [(P1 –P0)/P0]x
• 100
Types of Inflation Based on Rates of
Inflation
•
On the basis of the rate of price rise, inflation is
classified into five categories.
(a) Creeping or moderate inflation
(b) Walking
(c) Running
(d) Galloping
(e) Hyper Inflation
(a) When the rate of price rise is less than three per cent per
annum ,it is called creeping inflation
Contd.
(b)When inflation rate crosses the three per cent mark and
remains within single digits i.e. below the 10 per cent , it
becomes walking inflation.
• Walking inflation leads to a much rapid fall in the
purchasing power of money .
(c) When inflation rate is in double digits, it is known as
running inflation.
When prices begin to rise by more than 10% per annum and
the rate of inflation accelerates, money begins to flow
away from productive activities into unproductive or
speculative activities.
Contd.
(d) When prices rise by about 100%, the situation is known as
galloping inflation and when the inflation rate is over
1000% per year, it is called hyper inflation.
Both galloping and hyper inflation signals the collapse of the
economy.
Productive activity is at an all time low people lose
confidence in the currency and the economy looks like
more of a barter economy.
Demand pull inflation
Demand-pull Inflation takes place due to rise in aggregate
demand.
Aggregate demand may rise due to combined effect of higher
demand from the various sectors of the economy such as
the firms, households and the government.
According to Keynes, inflation arises when there is an
inflationary gap in the economy.
Inflationary gap arises when aggregate demand is greater than
aggregate supply at full employment level of output,
supply cannot increase in response to increase in demand
and hence prices rise.
Contd.
(2) Cost-push Inflation-In the absence of rise in aggregate
demand, prices may rise due to increase in cost in terms
of higher wages, higher input costs and higher
profits.These are known to be autonomous increases in
costs.
(a) Wage-push Inflation
(b) Profit-push Inflation
(c) Input-Cost Inflation
Structural Inflation
These structural factors can be more specifically stated as
follows:
•
Shortage of agricultural goods
•
Limited resources
•
Shortage of foreign exchange
Stagflation
•
Stagflation is a situation when a high rate of inflation
takes place along with a contraction in output and
employment.
•
The term ‘stagflation’ came into existence in the 1970s
when several developed countries received a supply
shock in terms of rapidly rising oil process.
•
Causes of Stagflation:
(i) Supply Shocks
(ii) Inflationary Expectations
Causes of Inflation
•
Demand side Factors Causing Inflation
(1)Increase in Public Expenditure
(2) Deficit Financing
(3) Increase in Money Supply
(4) Corruption and Black Money
Supply Side Factors Causing Inflation
(1) Fluctuating Agricultural Growth
(2) Hoarding of essential goods
(3) Inadequate rise in Industrial Production
Effects of Inflation
• The effects of inflation depend upon the nature of inflation.
• Factors such as the rate of inflation, whether the rate of inflation is
stable , whether the inflation rate is anticipated or unanticipated and
what is the domestic inflation rate as compared to the inflation rate in
the trading partner countries determine the consequences of inflation.
• When the rate of inflation is growing at an increasing rate, it is known
as accelerating inflation.
• When the inflation rate is stable, the actual inflation rate may take
place in a narrow band of plus or minus two percent i.e. the actual
inflation rate may be less than or greater than the average inflation rate
by plus or minus two percent over a certain period of time.
Contd.
• When the inflation rate is according to expectations, it is
known as anticipated inflation.
• When the actual inflation rate is greater or less than than
the expected inflation rate ,it is known as unanticipated
inflation rate.
• The cost of converting financial assets from one form to
another form in order to earn a higher rate of return is
known as Shoe Leather Cost.
• When price signals as a result of inflation becomes
confusing , inflation is said to be making inflationary
noise.
Contd.
• When inflation rate is accelerating and sustained, firms
will have to incur additional costs on catalogues, price
tags,bar codes and advertisements. Restaurants and hotels
will have to re-print their menu cards. The cost incurred on
such change is known as Menu Cost.
• Money illusion
• Income tax bracket creep
Effect of Inflation
(1) Effect on Inflation on Production and Economic Growth
(2) Effect of Inflation on Distribution of Income and Wealth
(3) Effect on Inflation on Consumption and Economic
Welfare
Measures to Control Inflation
(1)
(2)
(3)
(4)
Monetary Policy
Fiscal Policy
Public Distribution System
Supply Side Measures