Inflation

Inflation
If a slight rise in the prices of goods and commodities is accompanied by a rise in real income and economic development, then, it is not called inflation.

But when prices rise, costs rise and money income rises, but real income remains constant, we say that there is inflation.

Types of Inflation

1) Types of inflation based on speed of inflation:

Creeping Inflation Walking Inflation Running Inflation Galloping or Hyper Inflation

2) Demand pull inflation

When the effective demand for goods and services in an economy exceeds the existing supply of goods and services, prices tends to rise and result in the demand pull inflation. When the economy is operating at full employment level, an increase in the volume of money supply leads to demand pull inflation.

Cost Push Inflation

Cost push inflation may be caused by increased wages of organized workers or an attempt on the part of the industrialists to push up their profit margins. Sometimes, inadequate supply of raw material or obstacles in the transport also leads to cost push inflation. Finally, higher cost of production resulting in the rise in the prices.

3) Classification on inflation based on time period

Peace time inflation During peace time, as a result of governments expenditure on ambitious projects or unproductive purposes, inflation takes place. War time inflation During war period, huge expenditure on defense creates inflation. Post war inflation It takes place immediately after war because of relaxation of price and physical controls by the government. The pent up demand finds open expression causing inflation.

Causes of Inflation
Factors causing an increase in demand
Increase in public expenditure Increase in private expenditure Increasing in consumer spending Increase in money supply Monetary policy Deficit financing Reduction in taxation Repayment of public debt Increase in exports Black money

 Factors causing a Decrease in Supply

Shortage of factors of production Industrial disputes Natural calamities Trade policy Artificial scarcities Lopsided production Diminishing returns to scale Traditional production technique

Effects of Inflation
Effects on Production
Misallocation of Resources Changes in the system of transactions Reduction in production Fall in quality Hoardings and black marketing Reduction in saving Speculation Working of price mechanism

 Effects on Distribution
Creditors and Debtors Salaried persons Wage earners Fixed income groups Investors Farmers Government

 Other Effects
Balance of payments Financial institutions Exchange rate Collapse of monetary system Political Social

Measures to Control Inflation

Monetary Measures
These measures are adopted by the Central Bank of the country. These are,

To increase bank rate To increase cash reserve ratio Sale of Government securities in the open market Consumer credit control Higher margin requirement Direct control on credit supply Moral suasion

 Fiscal Measures
Government can adopt following fiscal measures to control inflation.

To reduce the government expenditure Increase in taxes Increase public borrowing Increasing in savings Surplus budget Debt management Overvaluation

 Other Measures
To increase production Wage policy Price control and rationing Public distribution of food grains through fair price shops Avoiding export of essential goods Import of essential goods Avoiding deficit financing

Deflation
Deflation is completely opposite of inflation.
During the period of depression, prices of goods and services decrease. The stock of finished goods increase in the go down and the volume of output is reduced. It leads to unemployment.

 Causes of Deflation
Increase in Production Increase in Taxation Government Policy Credit Control Policy Increase in Internal Public Debt Increase in Imports

Effects of Deflation
Effects on Production
Because of deflation, the values of stocks decrease. The cost of production is increased when prices are high and the products are to be sold when prices are low. This puts producers to a loss. Similarly, traders and wholesalers also incur losses, and trade and commerce is automatically reduced. The loss is luxury and durable commodities are large and their production is reduced substantially. This changes the consumption of production itself.

 Effects on Distribution
Producer Investors Consumers Debtors and Creditors Wage and Salary Earners

 Other Effects
The tax payers are adversely affected by deflation. Increase in the burden of public debt. Increase in unemployment Adverse effects on banking Increasing number of disputes between the employers and the employees.

Measures to Control Deflation

Monetary Measures
Deficit financing and public welfare works can be adopted for this. It will increase purchasing power in the hands of public leading to increase in demand. Reduction in interest rate In deflationary situation, the monetary authority should resort to a policy of cheap money. Expansion of credit At a time of deflation, the Central Bank as well as the Commercial banks should adopt a policy of credit expansion to promote business and industry. Open market operations (Purchase of securities) Liberal distribution of loans. Reduction in margin requirements.

Fiscal Measures
Reduction in taxation Increase in public expenditure Redistribution of income and wealth in favour of the poor Repayment of public debt Grant of subsidies

Other Measures
Promotion of Exports and Reduction in Import Regulation of production

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