Inflation – Meaning, Causes & Degrees
SCMS Pune
Definitions of Inflation
• Friedman:
– “ Inflation is always and everywhere a monetary
phenomenon …& can be produced only by a more
rapid increase in the quantity of money than output.”
• Dernberg & McDougall
– “The term usually refers to a continuing rise in prices
as measured by an index such as consumer price index
or by implicit price deflator for GNP.”
Inflation
• Inflation is a situation wherein the pressure of
aggregate demand for goods and services exceeds
the available supply of output and a natural
consequence of this is a rise in the general price-
level
Meaning of Inflation
• Inflation is a sustained or continuous rise in the general
price level or, a sustained or continuous fall in the value
of money.
• Inflation refers to the movement in the general level of
prices. It does not refer to changes in one price relative
to other prices.
• The rise in the price level must be somewhat substantial
and continue over a period longer than a two quarters.
Degrees of Inflation
• Creeping:
– Slow rise in price,
– Annual rise of about 2% – 3%,
– Considered good for an economy
– Provides incentive to the producers to continue production
• Walking/ Trotting:
– Moderate rise in price,
– Annual rise in the range of 4% – 5%,
– Needs to be controlled, else could become problematic
Degrees of Inflation Contd.
• Running:
– Prices rise rapidly at the rate of about 10% per annum
– Such inflation could have extreme adverse affects
– Hence, should be controlled
• Hyperinflation:
– Most dangerous type of inflation
– Prices rise every minute. Such a situation will collapse of
the monetary system.
Classification on the basis of Government Reaction
• Open Inflation
– Inflationary process in which prices are permitted to rise
– Government takes no measures to control the inflation
– Works on the basis of market mechanism
• Suppressed Inflation
– Government actively intervenes to control inflation
– This happens through various policy measures like –
monetary, fiscal, price, income, wages, etc.
Types of Inflation
Types of
Inflation
Demand Cost Push
Pull Inflation Inflation
Factors Causing Demand Pull Inflation
• Excessive increase in money supply
• Reduction in Taxes
• Increase in Demand for Exports
• Speculative tendencies
• Excessive production of investment goods
• Increase in income & wages
• Increase in population
Demand Pull Inflation – Diagram
P AS • When the aggregate demand
increases without the
corresponding increase in
P3 aggregate supply, it creates excess
aggregate demand situation
P2
AD3 • This excess demand pulls up the
P1 prices causing Demand Pull
AD2 Inflation
AD1
• Demand pull inflation is generally a
post full employment
phenomenon, as explained by
Qf Q Keynes.
Factors Causing Cost Push Inflation
• Increase in price of raw materials
• Increase in price of other inputs
• Power shortages
• Government policy
• Increase in rate of interest
• Increase in level of wages
Cost Push Inflation – Diagram
P AS • Initial equilibrium is at
point ‘e’
• With increase in costs the
e`
supply curve shifts
P2
P1 leftwards (S`)
e
• This causes the prices to
S` AD1 go up from P1 to P2
S causing cost push inflation
Qf Q
Interaction of Demand Pull & Cost Push Inflation
• Generally it is the one which causes inflation in an
economy
• Inflation may get triggered by Demand side factors
(Demand Pull) or by Supply side factors (Cost Push)
• However, once it gets triggered by either of the causes,
the other one adjusts itself
• Finally, the net inflation is a result of both Demand Pull
and Cost Push effects
Effects of Inflation
• Effects on Production
• Effects on Consumption
• Effects on Distribution
• Effects on Employment
• Effects on Savings
• Effects on Balance of Payments
• Non economic Consequences of Inflation
Control of Inflation
• Monetary Policy
– In the hands of the Central Bank/ RBI
– Works through the control of Money Supply in the
economy (interest rates, CRR & SLR; etc.)
• Fiscal Policy
– In the hands of the Government
– Works through the revenue generation & expenditure
mechanism of govt. (taxes, subsidy, etc.)