Meaning of Inflation / Types of Inflation
Inflation means persistent rise in the general level of prices. It is usually measured as a rate percent per unit time, say, a year or a month. Thus while talking of inflation, we speak of prices rising at the average rate of 15% or 20% or 100% per year (or per month).
Every where inflation is now regarded as a major economic problem. In some countries (such as Argentina, Brazi, Chile) the problem is chronic. But in recent years, inflation has taken hold of many more countries, whether developed, like the USA, the UK and Japan, or the LDCs. The two alarming features of the current world-wide phase of inflation are: (a) acceleration in the rate of inflation over time and (b) high (even rising) rate of unemployment in the face of high (even accelerating) rate of unemployment in the face of high (even accelerating) rate of inflation. The feature (b) has already earned new names such as stagflation and slumpflation and posed serious challenge (for explanation) to the received macro-economic theory.
Types of Inflation
(i) Currency inflation: This type of inflation is caused by the printing of currency notes.
(ii) Credit inflation: Being profit-making institutions, commercial banks sanction more loans and advances to the public than what the economy needs. Such credit expansion leads to a rise in price level.
(iii) Deficit-induced inflation: The budget of the government reflects a deficit when expenditure exceeds revenue. To meet this gap, the government may ask the central bank to print additional money. Since pumping of additional money is required to meet the budget deficit, any price rise may be called the deficit-induced inflation.
(iv) Demand-pull inflation: An increase in aggregate demand over the available output leads to a rise in the price level. Such inflation is called demand-pull inflation. But why does aggregate demand rise? Classical economists attribute this rise in aggregate demand to money supply. If the supply of money in an economy exceeds the available goods and services, DPI appears. It has been described by Coulborn as a situation of “too much money chasing too few goods.”
(v) Cost-push inflation: Inflation in an economy may arise from the overall increase in the cost of production. This type of inflation is known as cost-push inflation (henceforth CPI). Cost of production may rise due to an increase in the prices of raw materials, wages, etc.
Cost-push Inflation
Cost push inflation is inflation caused by an increase in prices of inputs like labour, raw material, etc. The increased price of the factors of production leads to a decreased supply of these goods. While the demand remains constant, the prices of commodities increase causing a rise in the overall price level. This leads to cost push inflation.
In this case, the overall price level increases due to higher costs of production which reflect in terms of increased prices of goods and commodities which use these inputs. This is inflation triggered from supply side.
Apart from rise in prices of inputs, there could be other factors leading to supply side inflation such as natural disasters or depletion of natural resources, monopoly, government regulation or taxation, change in exchange rates, etc. Generally, cost push inflation may occur in case of an inelastic demand curve where the demand cannot be easily adjusted according to rising prices.
Effects of Inflation
The effects of inflation can be divided into three categories:
1. Effect on distribution of income and wealth
2. Effect on economic Efficiency, and 3. Effect on long-run economic growth.
1. Effect on Distribution of Income and Wealth: An important effect of inflation is that it redistributes income and wealth in favour of some at the cost of others. Inflation adversely affects those who receive relatively fixed incomes such as salaried person and pensioners. Inflation brings windfall profits for the producers and traders.
2. Loss of Economic Efficiency: It is generally believed that inflation causes misallocation of resources and therefore results in loss of economic efficiency. Inflation causes distortions in prices which misallocates resources and result in inefficiency.
3. Effects of Inflation on Long-Run Economic Growth: Inflation slows down the rate of capital accumulation as it adversely affects savings. There are several reasons responsible for this. Firstly due to rapid inflation, value of money declines and people will, therefore, be eager to spend it before its value goes down heavily. This raises their consumption demand and therefore lowers their saving. Besides, people find that the rapid inflation will erode the real value of their savings. This discourages them to save. However, mild inflation is good for the economy.
