Inflation

Inflation means a sustained rise in prices. A situation is said to be an inflationary situation when, either the prices of goods and services or money supply rise. Friedman mentioned inflation as ‘always a monetary phenomenon’. But most of the economists today (including me), do not agree that money supply alone is the cause of inflation. Commonly Inflation is termed as continuing rise in prices as measured by an index such as consumer price index (CPI) or by the implicit price deflator for Gross National Product (GNP).
Generally Inflation can be divided into nine major types according to its intensity and nature. These types are as follows:

1- Creeping Inflation: When prices rise at very slow rate, i.e. creeper’s speed, it is called ‘creeping inflation. Generally 3% annual rise in prices is considered as ‘creeping inflation’.

2- Walking or Trotting Inflation: When inflation is in between 3% to 7%, it’s regarded as ‘walking or trotting inflation’. Some economists have extended the boundary of this type of inflation up to 10% per annum. This type of inflation is considered as a warning signal for the government to take some measures to control the situation.

3- Running Inflation: This type of inflation comes into action when there’s a rapid rise in prices and the range of this type lies in between 10% to 20% per annum. This type of inflation is controllable only by strong monetary and fiscal measures, lest it will be turned into ‘hyper inflation’.

4- Hyper Inflation or Galloping Inflation: The rise of prices from 20% to 100 % per annum is regarded as ‘hyper inflation’ or ‘galloping inflation’. This case of inflation is un controllable.

5- Demand Pull Inflation: This type of inflation is results as an excess demand. In this case supply remains constant (couldn’t be upgraded as per demand). So consequently, the prices go up.

6- Cost Push Inflation: When there’s increase in money-wages at speedier rate than that of the rise in the productivity of labour, it results as increased cost of production which furthers the increase in prices. This type of inflation is regarded as cost push inflation.

7- Mixed Inflation: Majority of the economists hold that, inflation is neither completely ‘demand pull’ nor completely ‘cost push’, the actual inflationary process contains the elements of both. Excess demand and increase in money wages operate at the same time, but it’s not necessary that they start at the same time.

8- Markup inflation: Garner Akley put forward the theory of ‘mark up inflation’. In simple words it is an advanced explaination of ‘Mixed inflation’. According to Akley First comes demand pull inflation, and it is led by cost push inflation. Markup inflation comes to happen when excess demand increases the prices, which stimulates the production. The increasing production creates excessive demand for the factors of production, and the excessive demand for the factors of production further raises the prices.

9- Stagflation: Stagflation is a situation, whereby economy faces stagnation of output and unemployment along with a high rate of inflation. This situation is also known as ‘inflationary recession’.

CAUSES OF INFLATION:

Inflation comes to happen when the aggregate demand exceeds the aggregate supply. The major factors causing inflation can be classified as under.

A- Demand side factors:

1- Increase in nominal money supply: Increase in nominal money supply without corresponding increase in output increases the aggregate demand. The higher the money supply the higher will be the inflation.

2- Increase in disposable income: When the disposable income of the people increases, their demand for goods and services also increases.

3- Expansion of Credit: When there’s expansion in credit beyond the safe limits, it creates increase in money supply, which causes the increased demand for goods and services in the economy. This phenomenon is also known as ‘credit-induced inflation’.

4- Deficit Financing Policy: Deficit financing raises aggregate demand in relation to the aggregate supply. This phenomenon is known as ‘deficit financing-induced inflation’.

5- Black money spending: People having black money spend money lavishly, which increases the demand un-necessarily, while supply remains unchanged and prices go up.

6- Repayment of Public Debts: When government repays the internal debts it increases the money supply which pushes the aggregate demand.

7- Expansion of the Private Sector: Private sector comes with huge capitals and creates employment opportunities, resulting in increased income which furthers the increase in demand for goods and services.

8- Increasing Public Expenditures: Non developmental expenditures of government lead to raise aggregate demand which results as increased demand for factors of production and then increased prices.

B- Supply side factors

1- Shortage of factors of production or inputs: Shortage of factors of production, i.e. raw material, labour capital etc causes the reduced production, which causes the increase in prices.

2- Industrial Disputes: When industrial disputes come to happen, i.e. trade unions resort strikes or employers decide lock outs etc the industrial production reduces. And as a short supply of goods in the market the prices go up.

3- Natural Calamities: Natural disasters, invasions, diseases etc effect the agricultural production, and shortage of supply which furthers the rise in prices.

4- Artificial Scarcities: Hoarders, black marketers and speculators etc create artificial shortage to earn more profits by keeping the prices high. (in Pakistan bird flu dilemma and sugar crises are the major examples in this regard)

5- Increase in exports (excess exports): When the country has tends to earn maximum foreign exchange and exports more and more without considering the domestic use of the commodities, it creates a shortage of commodities at home which increases the prices. (With reference to Pakistan, the failure of export bonus scheme during 1950’s is the most common example of this type of cause of inflation)

6- Global factors: This factor includes the changing global environment. Most common example is the rise in oil prices. This factor of inflation may vary in nature, i.e. it can be political, strategic, economic or logistic in nature.

7- Neglecting the production of consumer goods: When the production of consumer goods is neglected with reference to the increased production of luxuries, it also creates inflation. For example in Pakistan, in last couple of years our services sector has grown with the highest rate of 8.8% (mainly telecom sector), while basic necessities have been ignored which created increase in the prices of consumer goods.

8- Application of law of diminishing returns: this law applies when the industries use old machines and methods and, which increase in cost by increasing the scale of production. This furthers the increase in prices and hence inflation bursts out.

Effects of Inflation:

A- Effects on different sectors of the economy:

1- Effects on the distribution of income and wealth: Inflation causes the un-even distribution of wealth, which makes some people to have a luxurious life while others to spend their lives hand to mouth. Poor and middle class people are major targets of inflation. While businessmen, speculators etc earn maximum gains. Thus inflation creates un justified transfer of wealth and income from poor to rich.

2- Effects on production: Increasing prices make the producers to invest more in the production, it’s useful up to the full employment level, but investment beyond this level adversely effects the production.

3- Effects on the Government: During inflation government can impose more taxes on producers and hence it can earn more revenues during the period of inflation.

4- Effects on the Balance of Payment: Balance of trade is also adversely effected by inflation, when the domestic products are costlier than that of products made in foreign countries, people prefer imported products, whish increases the imports and decreases the exports.

5- Effects on Monetary Policy: Inflation causes the decline in the value of money, and ultimately the monetary system collapses.

6- Effects on Social Sector: As inflation widens the gap between the poor and the rich, it causes social disorders in the society.

7- Effects on Political environment: Hyper inflation also encourages the opposition parties to agitate and protest against the government which makes disturbance on the political stage of the country.

B- Effects on Different classes of the people:

1- Debtors & Creditors: During inflation debtors gain while creditors have to face the losses. This is because the debtors repay the less amount than that of the amount they have borrowed (because of the decline in the value of money).

2- Salaried Class: Salaried persons face a situation of loss because their salaries don’t increase at the same rate with which the prices are increasing.

3- Wages earners: Wage earners also face loss because the wage rate is adjusted with the rate of inflation. If the unions are strong they can be protected, lest they have to face a tough time.

4- Fixed income group: Fixed income group (pension, social securities earners etc) also face loss because they have to be content at their fix income.

5- Investors and shareholders: Share holders of joint stock companies earn good profits during inflation while those who invest in the bonds, debentures and securities etc earn losses.

6- Businessmen: Business class earns gains during inflation.
7- Agriculturists: Agriculturists both land lords and farmers have to undergo losses, because former get fix rents while later gets fix wages.

Remedies to control Inflation:

A- Monetary Measures

1- Credit Control: Central bank can adopt various methods to control the credit. It can raise the bank rate. Demand pull inflation can be easily controlled by the central bank by following a strong monetary policy.

2- Demonetization of the currency: Under this method the currency of higher denomination can be withdrawn. This measure is effective to control the black money circulation.

3- Issue of new currency: The issue of new currency is the extreme measure of monetary policy. Under this method new currency is issued to replace the old one and the value of deposits is fixed accordingly. However, this measure is taken when there’s hyperinflation.

B- Fiscal Measures

1- Curtailment in unnecessary expenditures: Under this measure the government lessens its some non developmental expenditure. It is, however, not an easy task for the government to reduce its expenditures. Then it is therefore better to be supplemented by taxation measures.

2- Increase in rate of taxes: In order to maintain the flow of money government can impose increased taxes over corporate and high income groups.

3- Increase in volume of savings: Savings also play an important role in the reduction of the effects of inflation. Saving either it is voluntary or in voluntary plays a major role in this regard.

4- Anti inflationary budgetary policy: This measure suggests relying more on surplus budget and avoiding deficit budget. This can happen only when government will reduce the unnecessary expenditures.

5- Increasing public debt policy: Under this measure government should postpone the repayment of public debts until the inflationary pressure lessens.

C- Non-Monetary and Non Fiscal Measures

1- Increase in volume of production: This measure can work as follows:

a- Production of consumer goods
b- Import of raw material rather than the finished goods
c- Rational labour policy
d- Rational industrial policy (long term)
e- Use of latest technology

2- Price control and rationing policy: Price controlling and rationing are two very important measures to reduce the inflation. Under price control the prices of essential goods can be fixed while rationing allows efficient distribution of commodities in all the areas at reliable prices.

REFERENCES

1- K.K.Dewett (Modern Economic Theory)

2- P.A.Samuelson (Economics)

3- Micheal PArkin (Economics)

9 Responses

  1. Wow,nice article but nearly went above my head cos its not much of my field!!! Waisay its too much explained!!!

    P.S: I din knew you were a blogger as well,glad to hear you are blogging as well as i love it too!!! Adieu

  2. very informative article , specially for studnts.
    it really meant alot to me .
    nice work keep it up,,,,,,

  3. excellent piece of research work, all in one article , highly informative at least for me .
    good job done !

  4. @Khushal

    Yes, i’ve explained it too much, but dear you’ll need it in CSS exam.

    @Suleman & Sheryaar

    Thnx a lot for the appreciation

    Regards,

  5. its good and i hope it would help me in making my assignment

  6. very informative article , specially for studnts.i liked it . keep it up

  7. Its nicely defined and well organized. i liked it and i appreciate your efforts for ur search and arrangement of information. i pray that in future u will also help the new comers (like me). thanks

  8. I love your article, I’m currently writing an essay on how to reduce inflation in my country and your piece has helped me a lot. Very detailed, although some things I would have liked clarification on such as stronger monetary policy, but then again that would be a MUCH bigger writing. Thank you

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