Inflation

Definition, types and causes of inflation

Areas to focus on

What Is Inflation?• Inflation is an increase in the average level of prices, not a

change in any specific price.• Inflation is a phenomenon whereby general price level rises

persistently. • According to Prof. Crowther,• “Inflation is a state in which the value of the money falls and

price level persistently rises.”• Prof. Ackly, “inflation is a persistent and appreciable rise in

the general value of average prices”.• Prof. Piguo, “inflation takes place when price level expands

more proportion to output”.

Types of inflation on the basis of inflation rate

• Creeping inflation• 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.

• 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.

Continued….

• Running inflation. Under running inflation, the price increase is about 8 to 10 percent per annum.

• 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.

Social Tensions

• Tensions between labor and management, between government and the people, and among consumers may overwhelm a society and its institutions.

Money Illusion

• The use of nominal Rupee rather than real to gauge changes in one’s income or wealth is called the money illusion.

Macro Consequences

• Inflation can alter the rate and mixes of output by changing consumption, work, saving, investment, and trade behavior.

Uncertainty

• People tend to shorten their time horizons in the face of inflation uncertainties.

• Time horizons are shortened as people attempt to spend money before it loses further value.

Speculation

• Few people will engage in production if it is easy to make speculative profits.

• Such speculation may fuel hyperinflation.– Hyperinflation is an inflation rate in excess of

200 percent, lasting at least one year.

Bracket Creep

• Bracket creep is the movement of taxpayers into higher tax brackets (rates) as nominal incomes grow.

Deflation Dangers

• Deflation — a falling price level — might not make people happy either.

• Deflation reverses the redistributions caused by inflation.

• Lenders win and creditors lose.

Measuring Inflation

• Measuring inflation serves two purposes:– Gauges the average rate of inflation.– Identifies its principal victims.

Causes of Inflation

• The cause of inflation is rooted in supply and demand.

Demand-Pull Inflation

• Demand-pull inflation results from excessive pressure on the demand side of the economy.

• “Too much money chases too few goods” enabling producers to raise prices.

Cost-Push Inflation

• The pressure on price could also originate on the supply side.

• Higher production costs put upward pressure on product prices.