133. Infliation, Deflation etc.,

Inflation, Deflation, Hyper Inflation and Stagflation

Inflation

Inflation has become a global phenomenon in recent years. It is a highly controversial term which has undergone modifications since it was first defined by the neo classical economists. The matter of concern for the common man and government alike is inflation. It is one of the important concepts in macroeconomics as it affects the day to day life of individual. Inflation in simple terms refers to rise in prices and because of which individuals feel the decrease in the value of money he holds. The situation of inflation can be seen both in the capitalist and socialist economies. Prof. COLBERT defines inflation as “too much of money chasing too few goods”. According to KEYNES during the period of under employment, the increase in money supply leads to increase in aggregate demand output and employment. Diminishing returns starts and certain bottleneck appears and price start rising. This process continuous till the full employment is reached. The rise in the price level during this period is known as BOTTLENECK INFLATION or SEMI INFLATION.

Inflation as a persistent and appreciable rise in the general level of prices, in such a way that:

1. Less than 3% CREEPING INFLATION
2. 3 to 10% annually WALKING INFLATION
3. About 10% annually RUNNING INFLATION
4. 20 to 30% monthly, GALLOPING INFLATION.

CONCEPT OF THE INFLATIONARY GAP

IN Keynes pamphlet “how to pay for the war” published in 1940, explained the concept of the inflationary gap.

Inflationary gap in the economy which comes to exist when aggregate demand exceeds aggregate supply at full employment level of output. The inflationary gap is the amount by which aggregate expenditure would exceed aggregate output at the full employment level of income. In other words it is a situation where resources coming forward to meet the demand.

Inflation is statistically measured in terms of percentage increase in the price index, as a rate percent per unit of time usually a year or a month. The trend of price indices reveals the course of inflation in the economy. Usually the wholesale price index {WPI} numbers are used to measure inflation. Alternatively the consumer price index or the cost of living index can be adopted in measuring the rate of inflation.

DEMAND PULL INFLATION

DEMAND PULL INFLATION arises when aggregate demand exceeds the currently available output. In other words demand pull inflation is caused by an increase in the aggregate effective demand for goods and services in the economy. There are many causes leading to demand pull inflation. They include:

1)    Increase in money supply

2)    Increase in disposable income

3)    Increase in public expenditure

4)    Deficit financing

5)    Expansion of credit. 

Cost Push Inflation

The cost push inflation is due to increase in production costs in other words, cost push inflation is caused by wage increases enforced by trade unions and profit increases by entrepreneurs. The theory of cost push inflation also called mark-up inflation. It attempts to explain the rise in prices when the economy is not at full employment. According to this theory, the prices, instead of being pulled by the excess demand, may also be pushed up as a result of rise in the cost of production. The basis of cost push theory is that organized groups, both business and labour fix higher prices for their products or services that would prevail in perfectly in the competitive market. Cost push inflation is categorized by insufficiency of aggregate demand, unemployment of resources and excess capacity.

Effects of Inflation

Inflation has different effects on different people. They are:

Effects on production:

It is argued that mild form of inflation has good effects on production. It stimulates production when there are unemployed resources and creates optimistic expectations about profit margin. However if prise rise even after the level of full employment it will adversely affect production.

Effects on distribution:

Inflation can have adverse impact on the distribution of income and wealth. Its impact is felt by various social groups such as debtors and creditors, business community, wage and salary earners, fixed income groups, investors and farmers.

Other effects:

Inflation leads to number of other effects. They are:

Social effects: Inflation is socially harmful. Social evils like bribery, corruption, black marketing, strikes etc may increase.

Political effects: Inflation results in the distribution of income and wealth in favour of the rich, there by leading to concentration of political power only in a few hands.

Anti inflationary measures;    

1. Monetary measures: Monetary policy is the policy of the central government to control the excess money supply in the economy to attain desired monetary objective. The two important tools of the monetary authority to control inflation are:

a)    Quantitative methods:

1. Bank rate policy
2. Open market operations
3. Increase in the cash reserve ratio

b)    Qualitative methods:

1. Rationing of credit
2. Consumer credit control
3. Rise in the margin
4. Moral suasion
5. Publicity
6. Direct action
7. Fiscal policy: Fiscal policy is the budgetary policy of the government relating to taxes, public expenditure, public borrowing and deficit financing. The important tools in the hands of government are:

a)    Increase in taxation

b)    Reduction in public expenditure

c)    Increase in public borrowing

d)    Control of deficit financing

Questions

1)    “Inflation is purely a monetary phenomenon”. Comment.

2)    Analyse the positive effects of inflation.

3)    How do you account for inflation in an under developed country having less than full employment?

4)    Inflation uncontrolled will be dangerous to the economy. Justify.

5)    Concept of Inflation is ill. Define.

6)    What is the effect of a fall in the value of money on investors?

Deflation:

Deflation is the opposite of inflation. It is a state in which the value of money is raising that is prises are falling. In other words, Deflation is associated with falling prises and raising value of money. According to CROWTHER, “deflation is that state of economy where the value of money is rising or the prices are falling”.

Thus, deflation occurs at that time when the output of goods and services increase at a faster rate than the money income. In other words, deflation is caused when prices are falling more than proportionately to the output of goods and services in the economy.

Causes of deflation

1. Deflation is due to excessive contraction of money supply.
2. Due to over production and consumption
3. Deflation can also occur due to heavy taxation.
4. It may occur due to increase in bank rate, reserve ratio and due to sale of securities by the monetary authorities.

Effects of Deflation

The effects of deflation are the reverse of inflation. It affects different groups such as producers, farmers, workers, investors, consumers, debtors and creditors.

Control of Deflation

Deflation can be controlled by monetary measures, fiscal measures and other measures. In monetary measures increasing the supply of money, encouraging the creation of credit are included. In fiscal measures, following deficit financing, cut in taxes, implementation of development projects, increase in public expenditure, price subsidy etc, are prominent.

Questions

1. “Deflation is a state of disequilibrium in which a contraction of economic power tends to cause, or is the effect of a decline of price level”. Comment.
2. “Inflation is unjust & deflation is inexpedient; of the two perhaps deflation is the worst.” Elucidate.
3. Deflation is the opposite of inflation. Justify.

Stagflation:

Stagflation refers to a situation when a high rate of inflation occurs simultaneously with a high rate of unemployment. The existence a high rate of unemployment means the reduced level of GNP. The term stagflation was coined in the 70’s when several developed countries of the world, received a supply stock in terms of rapid hike in oil prices. In 1973, the Cartel of Oil Producing Countries OPEC raised the price of oil. There was a four times increase in the oil prices. In the United States during 1973-75 the higher costs of fuel-oil & other petroleum products brought about a sharp increase in the prices of manufactured goods. The rate of inflation went up to over 12 % during 1974 in USA. A severe recession, the worst since 1930’s, also hit the American economy during the period 1973-75. The real GNP declined between late 1973 & early 1975. As a consequence, the rate of unemployment shot up to nearly 9%.Thus both inflation & unemployment were unusually very high during this period (1973-75). This simultaneous occurrence of high inflation & high unemployment was also seen in case of other free market developed countries such as Britain, France, & Germany. The recovery from Recession began in 1975 & over the next few years GNP rose & unemployment declined. Inflation rate also declined from over 12% to the range of 5-7%.

But, again in 1979 when a revolution in Iran created a crisis in world oil market, OPEC doubled the price of oil. This brought back stagflation again in 1979 in the developed countries. Real GNP fell at a rapid rate during 1979-81.

What causes stagflation?

The major reasons for stagflation, whenever it has occurred in history, have been-supply shocks or shortages due to unforeseen reasons which push up prices of essential commodities, causing an inflationary situation and at the same time pushing up production costs, as it happened in 1970s in the US. The other reason is failure of the monetary authority to control excessive growth of money supply in the economy and excessive regulation of goods and labor markets by the government. For example, in the 1970s, a similar situation occurred during the global stagflation, where it began with a huge rise in oil prices, but then continued as central banks used simulative monetary policy to counteract the resulting recession, causing a runaway wage-price spiral.

Questions:

1. Stagflation is when the domestic economy of a country fails to grow but prices rise anyway. Comment.
2. Stagflation describes the combination of slow economic growth and high rate of unemployment along with continuous rise in prices. Justify

Hyper inflation

Hyper inflation is also called as galloping inflation, jumping inflation and running inflation. It refers to the situation where the price level rises very rapidly. Generally in this case, the price level doubles up every two months; sometimes every week. It is the most dreaded form of inflation. This type of inflation is often caused by the issue of too much of currency notes. This kind of inflation results in lack of confidence of the people in the currency.

Hyperinflation results from a rapid and continuing increase in the supply of money, which occurs when a government prints money or creates credits in bank accounts, instead of collecting taxes to fund government activities. The price increases that result from increased government spending create a vicious circle, requiring ever increasing amounts of money creation to fund government activities. Hence both monetary inflation and price inflation rapidly accelerate. Such rapidly increasing prices cause widespread unwillingness of the local population to hold the local currency as it rapidly loses its real value. Instead they quickly spend any money they receive, which rapidly increases the velocity of money flow which causes further acceleration in prices.

Questions:

1. Can hyper inflation be controlled?
2. What caused hyper inflation in Germany?
3. Hyper inflation results in lack of confidence of the people in the currency. Comment.

Navya M.A.

Navya is available  for Consultation through the Institute