INFLATION

 Inflation is defined as a sustained increase in the general level of prices for

goods and services in a county, and is measured as an annual percentage
change. Under conditions of inflation, the prices of things rise over time. Put
differently, as inflation rises, every dollar you own buys a smaller percentage
of a good or service. When prices rise, and alternatively when the value of
money falls you have inflation.
 TYPES OF INFLATION
Creeping Inflation -: Circumstance where the inflation of a nation increases
gradually, but continually, over time. This tends to be a typically pattern for many
nations. Although the increase is relatively small in the short-term, as it continues
over time the effect will become greater and greater. Creeping or mild inflation is
when prices rise 3 percent a year or less.
Walking Inflation -: This type of strong, or pernicious, inflation is between 3-10
percent a year. It is harmful to the economy because it heats up economic growth
too fast. People start to buy more than they need, just to avoid tomorrow's much
higher prices. This drives demand even further, so that suppliers can't keep up.
More important, neither can wages. As a result, common goods and services are
priced out of the reach of most people.
Galloping Inflation -: Very Rapid Inflation which is almost impossible to reduce. When
inflation rises to 10 percent or more, it wreaks absolute havoc on the economy. Money
loses value so fast that business and employee income can't keep up with costs and
prices.
Hyper Inflation -: Hyperinflation is caused mainly by excessive deficit spending (financed
by printing more money) by a government, some economists believe that social
breakdown leads to hyperinflation (not vice versa), and that its roots lie in political
rather than economic causes.

On the basis of Government Reaction, inflation may be classified into

Open Inflation -: Inflation is said to be ‘open’ when the government and the monetary
authorities of a country do not take any measure to control the spending of the people.
The people spend their increased incomes freely. As a result there occurs a sharp rise in
demand and prices. If the people are allowed to spend their larger incomes on goods
freely, prices will continue to rise sharply.
Suppressed Inflation -: Existing inflation disguised by government Price controls or other
interferences in the economy such as subsidies. Such suppression, nevertheless, can only
be temporary because no governmental measure can completely contain accelerating
inflation in the long run. It is Also Called Repressed Inflation.
 On the basis of time, inflation may be classified into (a) peacetime inflation, (b)
war-time inflation and (c) post-war inflation.
Peace-Time Inflation:
By peace-time inflation we mean the rise in prices during normal period of peace.
This type of inflation occurs when, in a less-developed economy, the government
increases expenditure on development projects which normally have longer
gestation periods.
It means a gap arises between the generation of money income and the final
availability of goods, this leads to a rise in prices.
2. War-Time Inflation:
War-time inflation occurs during a period of war. During war time, unproductive
government expenditure increases and the prices rise because the increase in
output does not keep pace with the expansion of expenditure.
3. Post-War Inflation:
Post-war inflation occurs after the end of the war when the pent-up demand finds
open expression.
Heavy taxes, which were imposed on the people during war time, arc withdrawn
during postwar period. As a result the disposable income of the people abruptly
increases without increase in the output. Hence the prices shoot up.

On the basis of scope, inflation may be classified into

Comprehensive Inflation : When the prices of all goods and services throughout
the sectors of the economy rise, it is called economy-wide or comprehensive
inflation. This leads to a rise in the general price level.
Sporadic Inflation : Sporadic inflation is sectorial inflation.
 Causes of Inflation
1. The Money Supply
Inflation is primarily caused by an increase in the money supply that outpaces economic
growth.
When the Federal Reserve decides to put more money into circulation at a rate higher
than the economy’s growth rate, the value of money can fall because of the changing
public perception of the value of the underlying currency. As a result, this devaluation
will force prices to rise due to the fact that each unit of currency is now worth less.
2. The National Debt
The reason for this is that as a country’s debt increases, the government has two
options: they can either raise taxes or print more money to pay off the debt.
A rise in taxes will cause businesses to react by raising their prices to offset the
increased corporate tax rate. Alternatively, should the government choose the latter
option, printing more money will lead directly to an increase in the money supply,
which will in turn lead to the devaluation of the currency and increased prices
3. Demand-Pull Inflation
Demand-pull inflation occurs when there is an increase in aggregate demand, categorized by
the four sections of the macroeconomy: households, businesses, governments and foreign
buyers. When these four sectors concurrently want to purchase more output than the
economy can produce, they compete to purchase limited amounts of goods and services.
Buyers in essence "bid prices up" again, causing inflation. This excessive demand, also
referred to as "too much money chasing too few goods," usually occurs in an expanding
economy.

4. Cost-Push Inflation
Aggregate supply is the total volume of goods and services produced by an economy at a
given price level. When there is a decrease in the aggregate supply of goods and services
stemming from an increase in the cost of production, we have cost-push inflation. Cost-push
inflation means prices have been "pushed up" by increases in costs of any of the four factors
of production (labor, capital, land or entrepreneurship) when companies are already running
at full production capacity. With higher production costs and productivity maximized,
companies cannot maintain profit margins by producing the same amounts of goods and
services. As a result, the increased costs are passed on to consumers, causing a rise in the
general price level (inflation).
Effects of Inflation
Inflation has multi-dimensional effects on an economy. Effects of inflation on different sectors
and segments:
 On Creditors and Debtors
Inflation redistributes wealth from creditors to debtors i.e. lenders suffer and borrowers benefit
from inflation. This is true assuming that salaries would also increase due to price rise. This
results in repaying the same amount of money with extra money at hand due to wage hike or
increase in Dearness Allowance (DA for government employees).
 On Aggregate Demand
Rising prices usually results in higher demand as it comparatively lower supply. However if
inflation results from higher input costs (cost-push), aggregate may demand may or may not
increase comparative to price rise.
 On Investment
Inflation increases the investment in an economy in the short run as it encourages producers to
expand or increase production. Also, in the short run, higher the inflation lower is the cost of
loan.
 On Saving
In the short run, rising prices encourages people to deposit cash in hand with banks as money
loses value so holding it does not much sense. However in the long run, rising prices depletes the
saving rate in an economy.
 On Exchange Rate
Rising prices generally leads to depreciation of the currency which implies that the
currency loses its exchange value in front of a foreign currency. But this is relative to the
pressure on the foreign currency against which the exchange rate is compared. For
instance, from 2013 till mid-2014, even though there was relatively high inflation in
India, still it did not lose much value vis-a-vis the US dollar since the dollar was also
under inflationary pressure.
 On Export
With inflation, exportable items of an economy gain competitive prices in the world
market. This boost a country’s exports. This happens since value of currency falls so it
makes it cheaper for importing countries to buy the exporting countries produce.
 On Imports
Inflation gives an economy advantage of lower imports and import-substitution as foreign
goods become costlier.
 On Wages
Inflation increases the nominal or face value of the wages while its real value falls.
Simply put, even though wages may increase to offset inflation the actual value of money
falls.
 Measurement Of Inflation
Inflation can be measured by two methods, namely, by determining changes in
Price Index Numbers (PINs) and by comparing changes in Gross National Product
(GNP) deflator.
(a) Consumer Price Index (CPI):
Refers to the price index that measures the change occurred in the prices of
consumer goods and services purchased by households over a period of time. The
Bureau of Labor Statistics, U.S., has defined CPI as “a measure of the average
change over time in the prices paid by urban consumers for a market basket of
consumer goods and services.”
(b) Wholesale Price Index (WPI):
Refers to the price index that is used to estimate the average change in price of
goods in wholesale market. W PI is also known as Producers Price Index (PPI). It is
different from CPI as the amount paid by consumers does not come directly to
producers. This is because of the reason that the revenue generated from the
sales of goods and services is subject to price subsidization, profits, and taxes.
Apart from PIN, GNP deflator is also used for the measuring the rate of inflation.
GNP deflator is the measure of price levels of all the final goods and services
produced in an economy in a specific period of time.
 Formula used for the calculation of GNP deflator is as follows:
GNP Deflator = (Nominal GNP ÷ Real GNP) * 100
Where Nominal GNP = GNP at current prices
Real GNP = GNP at constant prices
The percentage change in GNP deflator of two consecutive years provides the rate
of inflation.
Remedies of inflation:

 Inflation is generally controlled by the Central Bank and/or the government. The
main policy tools to control inflation include:
Monetary policy – Setting interest rates. Higher interest rates reduce demand,
leading to lower economic growth and lower inflation
Control of money supply – Monetarists argue there is a close link between the money
supply and inflation, therefore controlling money supply can control inflation.
Supply-side policies – policies to increase competitiveness and efficiency of the
economy, putting downward pressure on long-term costs.
Fiscal policy – a higher rate of income tax could reduce spending and inflationary
pressures.
Wage controls. Trying to control wages could, in theory, help to reduce inflationary
pressures.