Inflation
Inflation can be generalized as an increase in the price level or it can be seen as a decrease in purchasing power of money. Inflation can be known as the increase in price level due to aggregate demand or aggregate supply of goods and services. Inflation can be driven by consumers, producers, or the government ( by decreasing taxes or increasing expenditures). The inflation rate is the increase in prices over time. Inflation is caused by an increase in the money supply or a decrease in interest rates. Inflation is measured using the consumer price index(CPI) or Producer Price Index (PPI). CPI measures the price changes of goods and services purchased by consumers while PPI measures the change in the cost of raw materials and labor.
Worldwide Impact
According to the World Bank, inflation was at 2.9% in 2018. The IMF also expected inflation to reach 6.0% in 2021 and 7.0% in 2022. The IMF’s forecast for inflation in 2022 is higher than the average inflation rate of 5.8% since 1980.
Characteristics of inflation
- The process of inflation never stops.
- It describes a rise in the general level of prices.
- The cost will go up significantly as a result.
- Money's purchasing power is reduced.
- It is the condition where there is an imbalance between total supply and total demand.
- Some economists believe that inflation is a result of the money supply.
Various Forms of Inflation Based on the Rate
- Modest or Creeping Inflation
Prices rising by 2% or less are advantageous for economic expansion. Consumers anticipate continued price increases as a result of this form of modest inflation. This increases demand. Customers purchase now to avoid future price increases.
- Mild Inflation
It fuels economic growth in this way. Strong inflation (between 3 and 10 percent), often known as destructive inflation, is bad for the economy since it speeds up economic growth. People start buying more than they need to avoid tomorrow's significantly higher prices. Because of the higher demand caused by this increased purchasing, providers are unable to keep up. More significantly, neither can pay. Common goods and services are therefore prohibitively expensive for the majority of people. operating the inflation.
- Running Inflation.
Running inflation is the term for when prices increase at a rate or pace of 10% annually, much like a horse running. Gleeful Inflation is when the rate of inflation exceeds 10%. Money depreciates so quickly that earnings from businesses and employees cannot keep up with rising costs and prices. The absence of foreign investors deprives the nation of much-needed funding. Government officials' reputation is damaged as well as the economy's instability.
- Hyperinflation
It is defined as a monthly increase in prices of more than 50%. It is really unusual. In reality, the majority of instances of hyperinflation involve governments printing money to finance wars. Germany in the 1920s, Zimbabwe in the 2000s, and Venezuela in the 2010s are just a few instances of hyperinflation.
Inflation Based on the Level of Employment
- Semi-inflation
Semi-inflation is the word used to describe the rise in the general price level below the point of full employment. As long as there are resources in the economy without jobs, general prices do not increase, according to Keynes. However, costs for some resources may grow gradually, resulting in an increase in price, if overall spending increases by a significant amount.
- Pure Inflation
Pure inflation is the inflation that takes place when the economy is operating at maximum capacity. Keynes argues that there is no more room to raise output once full employment is reached. As a result, the price level increases in line with the increase in commodity demand.
Various Forms of Inflation Based on Governmental Control
- Open Inflation
Open inflation is what happens when the government does nothing to stop the rise in prices and the market mechanism is allowed to operate unhindered.
- Reduced Inflation
It is referred to as controlling inflation if the government actively works to stop the price increase through price control and rationing. When these steps are taken back, the demand for goods rises, causing the previously-suppressed inflation to reappear as open inflation.
Types of Inflation by Expectations
- Inflation that is anticipated:
The rate of inflation that we anticipate. People can defend themselves from it.
- Inflation that is not anticipated:
Unexpected inflation is inflation that occurs at an unexpected rate. Debtors prosper while creditors are hurt in this type of inflation.
Inflation based on Cause
Demand-pull inflation: Positive shift in the aggregate demand curve causes an increase in the price level. Any improvements in consumption, investment, government spending, or net exports could increase AD. In the traditional scenario, the inflation is caused by an outward AD shift while the SRAS curve remains the same, ceteris paribus.
Causes of demand-pull inflation include an increase in bank lending and money supply, as well as an increase in public spending and private investment. Taxation reduction, export growth, and debt forgiveness for prior domestic obligations are also the causes. Increased circulation of illicit money due to the population's fast increase may be the cause of demand-pull inflation.
Cost-push inflation: A rise in the cost of production, such as higher taxes, labor costs, utility costs, or component prices. The SRAS curve will move negatively as a result of the cost rise. Costs drive the supply curve up the aggregate demand curve, which raises prices. A diagram illustrating how growing manufacturing costs over time can cause the economy to experience stagflation (inflation and negative growth). Any increase in the manufacturing cost factor typically causes the SRAS curve to shift inward (increase in wages or higher prices for commodities such as oil). However, external factors like foreign inflation and greater taxation could cause this curve shift.
Cost-push inflation and inflationary pressure factors
An increase in salaries and earnings
A rise in the cost of raw materials
An increase in producers' profit margins
Increased indirect tax rate Increased import costs
Increased capital costs
The other types of inflation based on causes are:
Scarcity Inflation
Deficit-induced inflation
Credit inflation
Mixed Inflation
Causes of Inflation
There are many causes of inflation. One of the major causes of inflation is monetary policy. Monetary policy refers to the actions taken by central banks to control the amount of currency in circulation and the interest rates they charge. Central banks use these tools to influence economic activity and stabilize their economies. Another cause of inflation is government spending. Government spending includes expenditures made by the federal government, state governments, local governments, and non-profit organizations. When governments spend more money than they take in taxes, this results in increased demand for goods and services. Increased demand for goods and services increases the costs of producing those goods and services.
How to calculate inflation?
Every year, the government keeps track of the costs for the same goods and services.
This "market basket" consists of typically bought items. A measure of the average change in price over time for a fixed group of goods is the consumer price index (CPI ) that is reported each month. It is reported in comparison to a predetermined (or base) time frame.
Market basket: a sample of products for everyday use. food, clothing, shelter, utilities, amusement, travel, and medical care. measured in dollars each month.
Inflation rate= (CPI current year – CPI base year)/CPI base year x 100
Effects
Increased inflation affects everyone differently. Higher inflation means that people have less purchasing power. People who rely heavily on fixed incomes may not be able to afford basic necessities. On the other hand, people who save money may benefit from rising inflation. Rising inflation makes saving money more attractive because it reduces the value of savings.
Solutions
To avoid inflation, we need to understand how it works and what factors affect it. We should also know how to identify and prevent inflation before it happens. There are several ways to reduce inflation. One way is to cut back on government spending. Another way is to lower interest rates. Lowering interest rates helps stimulate investment and encourages borrowing. A third way is to raise taxes. Raising taxes discourages people from consuming goods and services.
Control of inflation
It is a measure used by the central bank to regulate the flow of money through the economy. The greatest way to combat inflation is to reduce aggregate demand since inflation results from excess collective demand. By regulating the overall supply of money, monetary policies can significantly aid to decrease aggregate demand.
The following are Monetary policies:-
- Bank Rate Guidelines:
The central bank should increase the bank rate when there is inflation. Commercial banks will raise their interest rates as a result. The cost of borrowing will increase. Less money will be borrowed by people for investment and consumption purposes. As a result, there will be less demand for consumer and investment items, which will lessen inflationary pressure.
Other actions are: Controlling credit; demonetizing cash; and issuing fresh money. After demonetization, the economy of the country can be corrected by foreign currency also.
- Open Market Activity:
The sale of securities in the market is another way to reduce inflation. The open market selling of securities can also be used to reduce inflation. Commercial banks' ability to create credit and cash reserves is decreased by purchasing securities. The rise in prices will be restrained by a reduction in credit availability.
- The ratio of Cash Reserves:
The ability of commercial banks to create credit is likewise impacted by this instrument. By increasing the reserve ratio, the central bank can reduce inflation.
Fiscal actions
Spending reductions; Savings growth; Budget surpluses; Public debt
Other actions
Increasing output, rational wage policy, price control, and rationing