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Understanding Inflation and Its Effects

The document discusses various topics related to inflation including: 1. Definitions and measurements of inflation including creeping, galloping, and hyperinflation. 2. Effects of inflation such as its impact on income distribution and different groups in the economy. 3. Theories of inflation starting from Irving Fisher's seminal work in 1911 and the relationship between money supply and prices. 4. Causes of inflation including demand-pull factors, cost-push factors, and the inflationary gap concept. 5. Policy measures to control inflation involving monetary, fiscal, price and wage controls. 6. The Phillips curve relationship between inflation and unemployment and Okun's law on output and

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25 views10 pages

Understanding Inflation and Its Effects

The document discusses various topics related to inflation including: 1. Definitions and measurements of inflation including creeping, galloping, and hyperinflation. 2. Effects of inflation such as its impact on income distribution and different groups in the economy. 3. Theories of inflation starting from Irving Fisher's seminal work in 1911 and the relationship between money supply and prices. 4. Causes of inflation including demand-pull factors, cost-push factors, and the inflationary gap concept. 5. Policy measures to control inflation involving monetary, fiscal, price and wage controls. 6. The Phillips curve relationship between inflation and unemployment and Okun's law on output and

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© Attribution Non-Commercial (BY-NC)
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Kishor Bhanushali

Faculty – Economics
IBS-Ahmedabad
Increase in the general level of prices in an
economy that is sustained over a period of time is
called inflation
General price level
Sustained increase over time
Inflation is measured for a basket of goods and
services
Creeping inflation – smaller or gradual increase in
prices – single digit inflation rate
Galloping inflation – double or triple digit rate
Hyperinflation – large and accelerating prices
Distribution of income and wealth
The rich get richer and poor get poorer
Loss to fixed income earners
Gains to profit earners
Gains to the debtors
Loss to the creditor
Loss to wage earners
Government
Economic growth
Employment
The first and the comprehensive theory of
inflation was propounded by Irving Fisher in
1911
According to classical theory inflation occurs in
direct proportion to increase in money supply,
given level of output
MV=PT
Process is not explained
Money function only as medium of exchange
Inflationary gap is explained as the planned
expenditure in excess of output available at full
employment level
The inflationary gap is so called because it
causes only inflation, without increasing the
level of output
The inflationary gap generates only money
income without creating matching real output
because the economy is in full employment
equilibrium
The general level of prices rises only due to an
increase in the money supply
Inflation is always a monetary phenomenon ….
and can be produced only by a more rapid
increase in the quantity of money than in
output
Proportionate relationship is not propounded
Short term and long term, changes in the stock
of money
Aggregate price level of determined by the aggregate demand and
aggregate supply
Inflation is caused by both demand and supply side factors
Demand side factors are called demand pull factors
Supply side factors are called supply side or cost push factors
Demand pull factors
- monetary factors
- Increase in government spending, given tax revenue
- Cut in tax rate without change in government expenditure
- Upward shift in investment function
- Downward shift in saving function
- Upward shift in export function
- Downward shift in import function
Cost Push Inflation
- wage push
- Profit push
- Supply shock
Monetary Measures
- Bank rate policy
- Variable reserve ratio
- Open market operation
- Statutory liquidity ration
- Moral suasion
- Selective credit controls
Fiscal Measures
- Cut down in public expenditure
- Tax policy
Price and Wage Control
- Price control
- Wage control
- Indexation
[Link] 1958, London
School of Economics
Rate of Change in Money Wage Rates Relationship between
unemployment and the changes
in money wage rates in British
economy during the period
1861-1957
Phillips found inverse
relationship between the rate of
change in money wages and
rate of unemployment
There exist tradeoff between the
rate of unemployment and rate
of increase in money wages i.e.
lower rate of unemployment
can be achieved only by
Unemployment Rate allowing money wage rate to
increase
Arthur Okuns
Relationship between output and unemployment
Employment data 1950 and early 1960
Every one percentage point increase in
unemployment results in a 2.5 percent reduction in
real GNP below the natural rate
Okun’s law does not stand empirically
Inverse is also true
Recession causes fall in output and fall in output
causes unemployment

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