Inflation, its types,causes and measures

Inflation

Inflation means the condition of a substantial and rapid increase in the general price level which

causes a decline in the purchasing power of money. Inflation is statistically measured in terms of

percentage increase in the price index per unit of time.

There is no generally accepted definition of inflation and different economists define it

differently.

According to Crowther, “Inflation is a ‘state’ is which the value of money is falling i.e. the

prices are rising”.

According to Fried man, “Inflation is always and everywhere a monetary phenomenon”.

According to Keynes, “Inflation is the result of the excess of aggregate demand over the

available aggregate supply and true inflation starts only after full employment”.

Features of Inflation:

Inflation is always accompanied by a rise in the price level.

Inflation is a monetary phenomenon and it is generally caused by excessive money

supply.

Inflation is a dynamic process as observed over the long period.

A cyclical movement of prices is not inflation.

Pure inflation starts after full employment.

Inflation may be demand pull or cost push.

Excess demand in relation to the supply of everything is the essence of inflation.

Types of Inflation

According to Rate of Rise in Price

Anam Rauf (GCUF) Page 1

i) Creeping inflation: When the rise in prices is very slow like that of a snail or creeper, it called

creeping inflation. In terms of speed, a sustained rise in prices of annual increase of less than 3

percent per annum is characterized as creeping inflation. Such an increase in prices is regarded

safe and essential for economic growth.

ii) Walking inflation : When the rise in prices becomes more pronounced as compared to a

creeping inflation, there exists walking inflation in the economy. Roughly, when prices rise by

more than ten percent and within a range of 30 percent to 40 percent over a decade, or 3 to 4

percent a year, walking inflation is the outcome. Walking inflation presents a warning signal for

the occurrence of running and galloping inflation.

iii) Running inflation: When the movement of price accelerates rapidly, running inflation

emerges. Running inflation may record more than 100 percent rise in prices over a decade. Thus,

when prices rise by more than 10 percent a year, running inflation occurs.

iv) Galloping inflation: In the case of hyperinflation, prices rise every moment, and there is no

limit to the height to which prices might rise; therefore, it is difficult to measure its magnitude, as

prices rise by fits and starts. If, within a year, the prices rise by 100 percent, it is a case of

hyperinflation or galloping inflation.

2 . According to the factors influences money supply and demand for goods and services.

i) Excessive money supply inflation: This is classical types of inflation , where there is an

excess of money supply in relation to the availability of real goods and service/ This type of

inflation is usually conceived with reference to the cyclical fluctuations in the economy, and

measures of monetary control to check inflationary of deflationary trends.

ii) Cost inflation: When inflation emerges on account of a rise in factor cost, it is called cost

inflation. It occurs when money incomes (wage rate, particularly) expand more than real

productivity. Cost inflation has its course through the level of money costs of the factors of

production and in particular through the level of wage rates. Due to a rising cost of living index,

workers demand higher wages, and higher wages in their turn increase the cost of production,

which a producer generally meets by raising prices.

iii) Deficit inflation: When the government budgets contain heavy deficit financing, through

creating new money, the purchasing power in the community increases and prices rise. This may

be referred to as deficit-induced inflation.

3. War, post-war and peace-time inflation


i) War-time inflation: It is the outcome of certain exigencies of war, on account of increased

government expenditure, which is of an unproductive nature. By such public expenditure, the

government apportions a substantial production of goods and services out of total availability for

war which causes a downward shift in the supply; as a result, an inflationary gap may develop.

ii) Post-war inflation : It is a legacy of war. In the immediate post-war period it is usually

experienced. This may happen when the disposable income of the community increases when

war-time taxation is withdrawn or public debt is repaid in the post-war period.

iii) Peace time inflation : By this is meant the rise in prices during the normal period of peace.

Peace-time inflation is often a result of increased government outlays on capital projects having a

long gestation period; so a gap between money income and real wage develops.

4 . According to Coverage or scope point of view

i) Comprehensive inflation: When prices of every commodity throughout the economy rise, it

is called economy-wide or comprehensive inflation. It is a normal inflationary phenomenon and

refers to the rising prices of the general price level.

ii) Sporadic inflation : This is a kind of sectional inflation; it consists of cases in which the

averages of a group of prices rise because of increase in individual prices due to abnormal

shortage of specific goods. When the supply of some goods becomes inelastic, at least

temporarily, due to the physical or structural constraints, the sporadic inflation has its way.

5. Open and Repressed inflation:

Inflation is open or repressed according to government reaction to the prevalence of inflationary

forces in the economy.

i) Open inflation: When the government does not attempt to prevent a price rise, inflation is said

to be open. Thus, inflation is open when prices rise without any interruption. In open inflation,

free market mechanism in permitted to fulfill is historic function of rationing the short supply of

goods and distribute them according to consumer’s ability to pay.

ii) Repressed inflation : When the government interrupts a price rise, there is repressed or

suppressed inflation. Thus, suppressed inflation refers to those conditions in which price increase

are prevented at the present time though adoption of certain measures like price control and

rationing by the government, but they rise in future on the removal of such controls and

rationing. The essential characteristic of repressed inflation, in contract to open inflation, is that

is seeks to prevent distribution system based on controls.


6. Profit inflation: The concept of profit inflation was originated by Keynes in his Treatise on

Money. According to Keynes the price level of consumption goods is a function of the

investment exceeding savings. The considered the investment boom as a reflection of profit

boom. Inflation is unjust in its distribution effect. It redistributes income in favor our of

profiteers and against the wagering class.

7. Demand Pull inflation : In a market there is inter-action between the flow of money and flow

of goods and services. When more money chases relatively less quantity of goods and services

the excess of demand relative to supply pushes up the prices of goods and service. Such inflation,

as a result of increased money expenditure; is called demand-pull inflation.

8. Cost-Push Inflation : Often the demand-pull inflation precedes the cost push inflation. When

the former sets in there in an increasing demand for factors of production, the prices of these also

rise, leading to raise in general prices. It is called cost-push inflation which, however, may also

be due to rise in the price of imported material or even be profit inflation when entrepreneurs

exploit the scarcity conditions to secure higher monopolistic gains by raising price.

9. Stagflation: The combined phenomenon of demand-pull and cost push inflation is found in

many countries, both the developed and the developing. One of these situations is in the form of

stagflation under which economic stagnation, in the form of a low rate of growth , combines with

the rise in general price level. There are many factors contributing to this situation. The advanced

countries may show slow growth on account of the maturing of the economy. But the labor

unions are powerful and are successful in bargaining for higher wages which are not in keeping

with productivity leading to a situation of stagflation.

10. Semi-inflation: According to Keynes, so long as there are unemployed resources, the general

price level will not rise as output increased. But a large increase in aggregate expenditure will

face shortages of supplies of some factors which may not be substitutable. This may lead to

increase in costs, and prices start rising. This is known as semi-inflation or bottleneck inflation

because of the bottlenecks in supplies of some factors.

11. True inflation : According to Keynes, when the economy reaches the level of full

employment, any increase in aggregate expenditure will raise the price level in the same

proportion. This is because it is not possible to increase the supply of factors of production and

hence of output after the level of full employment. This is called true inflation.


12. Mark-up-inflation: The concept of mark-up inflation is closely related to the price-push

problem. Modern labor organization possess substantial monopoly power. They , therefore, set

prices and wages on the basis of mark-up over costs and relative incomes. Firms possessing

monopoly power have control over the prices charged by them. So they have administered prices

which increase their profit margin. This sets off an inflationary rise in prices. Similarly, when

strong trade unions are successful in raising the wages of workers, this contributes to inflation.

Causes of inflation are of two types:

A. Increase in demand:

1) Increase in Money Supply

The major cause of increase in the price level is an increase in money supply. It may be due to

increase in currency or credit money. Increase in the stock of money induces people to demand

more and more of goods and services.

2) Increase in Velocity of Money

According to the Fisher’s Quantity Theory of Money, if there is an increase in the velocity of

circulation of money it also leads to inflation.

3) More Investment

Investments also play an important role in producing inflation. At the moment of investment the

economy’s stock of wealth and money expands and it result is in inflation.

4) Non-productive Expenditures

Government of Pakistan has to make a lot of non-productive expenditures like defence etc. Such

unproductive expenditures lead to the wastage of economy’s precious resources and also lead to

inflation.

5) Corruption & Black Money

Corruption and black money leads to increase in aggregate demand, which is cause of inflation.

These evils increase aggregate demand and import volume.

6) Deficit Financing

Deficit financing is another cause of inflation. It increases the money supply and leads to

inflation.

7) Foreign Remittances

Increase in foreign remittances is increasing the money supply in our country. Increase in money

supply leads to inflation.


8) Foreign Aids

Foreign aids are also a source of mobilization of resources form rich countries to poor countries.

It is also a cause of inflation in Pakistan.

9) Consumption Trends

Due to demonstration effect people of our country want to copy the styles of people of rich

countries. In this way there is an increase in consumption trends that leads to inflation.

10) Population Bomb

Population of Pakistan is increasing day by day. Increasing population is demanding more and it

creates inflation.

B. Decrease in supply:

11) Slow Agricultural Development

Low growth rate of agricultural sector caused in shortage of productivity. It results in low supply

and increase in price level.

12) Slow Industrial Growth

Our industrial sector is not at developed form due to use of backward techniques of production.

Its less production also creates shortage in market and caused in inflation.

13) Increase in Wages & Salaries

Now labour is demanding more wages and salaries. Increase in wages and salaries leads to

increase in cost that increases the prices. On the other hand due to more wages and salaries there

is an increase in income and it caused in inflation.

14) Increase in Prices of Imports

Increase in the prices of imports also leads to creation of inflation. If there is an increase in the

prices of oil and other imported raw material then it will cause to reduction in supply.

15) Devaluation

Depreciation of Rupee: The Pakistani rupee is depreciating vis-à-vis the US dollar. The repeated

and higher devaluations of Pakistani rupee has increased the cost and prices of imported goods.

Depreciation of the currency thus is an important factor for the rise in the average level of prices

in Pakistan.

16) Indirect Taxes


The imposition of indirect taxes is a reason for increase in prices. Sometimes government

imposes taxes on some particular commodities. In this case producer may start to decline the

production of those goods.

Measures To Control The Inflation

Following measures are suggested to control high inflation:

1) Increase in the growth rate of output

2) Government should control the supply of money through effective monetary policy

3) Highly increasing unproductive expenditures must be control

4) Government should check the corruption first to eliminate the inflation

5) Control on population is also necessary to control inflation

6) Reduction in budget surplus

7) Reduction in monetary expansion

8) Effective tax system will be helpful to control the inflation

9) Improvement in balance of payment

Anti-Inflation Measures

The methods which are adopted to remove inflation, they are called anti-inflation measures.

These measure may be of the following three kinds.

1. Monetary Measures

2. Fiscal Measures

3. Non-Monetary Measures or General Measures.

1. Monetary measures

Monetary measures mean those measures which are taken by the Central Bank of the country.

Anti-inflationary measures of pure monetary nature are largely a matter of Central Bank policy.

These are discussed as under.

(i) Bank Rate Policy: In the time of need the people may discount the bills from commercial

banks. When there is inflation in the country then banks should increase the rate so that people

can not get cash by discounting the bills. This is the bank rate policy and is major weapon of

controlling the inflation.

(ii) Open Market Operation: When Central Bank sales or purchases the securities in open

market, it is called open market operation. If there is inflation in the country then central Bank

should sell the securities so that the inflation may be controlled.


(iii) Higher Reserve Requirements: Higher reserve requirements are also necessary to control

the inflation. Because of reserves are increased then purchasing power of people is also

decreased.

(iv) Monetary Reforms: The Government can order to exchange old notes by new ones in this

way a large part of money may be blocked. Money should be repaid to people after achieving the

purpose.

(v) Marginal Requirement: Marginal requirements mean the value of securities against which

banks agree to advance loans. If banks increase the marginal requirement then people can not get

more loans and inflation may be controlled.

(vi) Credit Rationing: Sometimes Central Bank advises to commercial banks to stop the

advancing loans for one month or two months or more. In this way inflation may also be

controlled.

2. FISCAL MEASURES

(i) Cut on Expenditure: If government decreases her expenditure on unproductive activities

then inflation is also automatically controlled.

(ii) Change in Taxation System: Tax system should be reorganised to encourage investment

and productive activities in the country. It may help to increase production and to control the

general price level.

(iii) Restriction on Exports: Government may control inflation by applying restriction on the

export of those goods which other wise may create shortage in the country.

(iv) Managing Public Debt: Public debt should be managed in such a systematic way that

money supply is reduced and consequently the inflation may be removed.

(v) De-nationalization: To control the inflation government should de-nationalize sick public

industries. The experience of nationalization of industries in Pakistan has been quite bitter for

economy.

(vi) Protection to Infant Industries: To control inflation, increase in domestic production is

required. So government should protect the domestic infant industries by applying import duties.

Conclusion:

Inflation is everywhere in an economy. Its rate is high in developing countries and is low in poor

developed counties. Effective operation of monetary and fiscal policy is essential to control the

inflation.



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Inflation, its types,causes and measures