Inflation
Inflation means a considerable and persistent rise in the general level of prices of goods and services in an economy over a period of time. When the general price level rises, each unit of currency buys fewer goods and services. Thus, inflation results in loss of value of money.
What are the causes of inflation?
(a) Demand Pull Inflation: In this type of inflation prices increase results from an excess of demand over supply for the economy as a whole. Demand inflation occurs when supply cannot expand any more to meet demand; that is, when critical production factors are being fully utilized, also called Demand inflation.
(b) Cost Pull Inflation: This type of inflation occurs when general price levels rise owing to rising input costs. In general, there are three factors that could contribute to Cost-Push inflation: rising wages, increases in corporate taxes, and imported inflation. [imported raw or partly-finished goods may become expensive due to rise in international costs or as a result of depreciation of local currency ]
What are the different types of Inflation?
Low Inflation/Creeping Inflation: This is also known as mild inflation or moderate inflation. This type of inflation occurs when the price level persistently rises over a period of time at a mild rate. When the rate of inflation is less than 10 per cent annually, or it is a single digit inflation rate, it is considered to be a moderate inflation.
Galloping Inflation: If mild inflation is not checked and if it is uncontrollable, it may assume the character of galloping inflation. Inflation in the double or triple digit range of 20, 100 or 200 percent a year is called galloping inflation .
Hyperinflation: It is a stage of very high rate of inflation. While economies seem to survive under galloping inflation, a third and deadly strain takes hold when the cancer of hyperinflation strikes. Nothing good can be said about a market economy in which prices are rising a million or even a trillion percent per year . Hyperinflation occurs when the prices go out of control and the monetary authorities are unable to impose any check on it.
Stagflation: It is an economic situation in which inflation and economic stagnation or recession occur simultaneously and remain unchecked for a period of time. Stagflation was witnessed by developed countries in 1970s, when world oil prices rose dramatically.
Deflation: Deflation is the reverse of inflation. It refers to a sustained decline in the price level of goods and services. It occurs when the annual inflation rate falls below zero percent (a negative inflation rate), resulting in an increase in the real value of money.
Bottleneck Inflation: It takes place when the supply falls drastically and the demand remains at the same level. Such situation arises due to supply-side accidents, hazards or mismanagement, which is also called structural inflation.
Core Inflation: It is based on the inclusion/exclusion of the goods and services. It represents the long run trend in the price level. In measuring long run inflation, transitory price changes should be excluded. One way of accomplishing this is by excluding items frequently subject to volatile prices, like food and energy.
How to control Inflation?
There are broadly two ways of controlling inflation in an economy:
- Monetary measures
- Fiscal measures
Monetary Measures
The most important and commonly used method to control inflation is monetary policy of the Central Bank. Most central banks use high interest rates as the traditional way to fight or prevent inflation.
Monetary measures used to control inflation include:
(i) bank rate policy
(ii) cash reserve ratio and
(iii) open market operations.
Bank rate policy is used as the main instrument of monetary control during the period of inflation. When the central bank raises the bank rate, it is said to have adopted a dear money policy. The increase in bank rate increases the cost of borrowing which reduces commercial banks borrowing from the central bank. Consequently, the flow of money from the commercial banks to the public gets reduced. Therefore, inflation is controlled to the extent it is caused by the bank credit.
Cash Reserve Ratio (CRR): To control inflation, the central bank raises the CRR which reduces the lending capacity of the commercial banks. Consequently, flow of money from commercial banks to public decreases. In the process, it halts the rise in prices to the extent it is caused by banks credits to the public.
Open Market Operations: Open market operations refer to sale and purchase of government securities and bonds by the central bank. To control inflation, central bank sells the government securities to the public through the banks. This results in transfer of a part of bank deposits to central bank account and reduces credit creation capacity of the commercial banks.
Fiscal Measures
Fiscal measures to control inflation include taxation, government expenditure and public borrowings. The government can also take some protectionist measures (such as banning the export of essential items such as pulses, cereals and oils to support the domestic consumption, encourage imports by lowering duties on import items etc.).
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