133. Infliation, Deflation etc.,

Inflation, Deflation, Hyper Inflation and Stagflation


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.


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 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


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 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.


  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 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.


  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.


  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




23 thoughts on “133. Infliation, Deflation etc.,

  1. Inflation seems to be a pure monetary phenomenon, but if we look closely we will understand that it is a phenomenon of political, social, psychological areas manifested into a monetary phenomenon.

    To understand this we should look at the root causes of Inflation. Inflation is caused by any of the following factors:
    1. Increased money supply: More money can be spent only when more money is available, in the form of salary, loan, subsidy or other benefits from the caretaker (Government).

    2. Purchasing ability and affinity: Regardless of the amount of supply, Purchaser should be able to purchase the available product, this ability could have been acquired by any of the forms mentioned in the above point. Another driving factor is the need / desire of the Purchaser to purchase the product. Here Purchaser can be an individual or an business entity.

    3. Competitive environment: One of the driving factor for spending more money is the desire to obtain the product, which itself is an outcome of a competitive environment. It can be either a Government or Individual or any private entity, there are chances that competitive environment will force the entity to enter into the cycle of increased demand->increased supply->increased demand.

    4. Lack of informed, objective vision: This factor is closely linked with the outcome of Competitive environment. Competitiveness can be boon or bane depending upon the goal of the competition. Any decision making entity either a group or a individual will contribute to the imbalance of the demand and supply if the visions are set and actions are taken by prioritizing the vested interests instead of objectivity.

  2. dear mithun
    your view towards causes of inflation is really good..Analysis of competitive environment as the major cause of inflation is interpreted nicely. all the best

    1. Deficit financing is said to be adopted by a government when its expenditure is more than its revenues i.e. it borrows money from its own citizens or other foreign nations due to lack of sufficient funds. Though usually construed to be a measure of inefficiency , it can also mean that the government has lowered tax rates to promote manufacturing(production) or that it has increased its public spending. Economists are of the view that a small deficit budget is necessary for growth as opposed to a balanced budget.

  3. Deficit financing is the most useful method of promoting economic development. the term “deficit financing is used to denote the direct addition to the gross national expenditure through budget deficits whether the deficits are on the revenue or capital accounts”
    It has been used by the government of india for mobilizing funds to finance economic development.

    1. dear arvind
      here one assumption called full employment to be noticed.. in demand pull inflation there will be no full employment condition as such. in demand pull inflation because of shortage of supply , the demand keeps on increasing, so price rises.. but in inflationary gap the aggregate demand exceeds the aggregate supply so that in full employment condition gap exists .

  4. Please ignore the previous post. Can you please explain the last 5 lines in the first paragraph. I am not very clear about “diminishing returns start and certain bottlenecks appear and prices start rising. This process continues till full employment is reached”.

    1. During underemployment, when quantity of money increases it leads to more employment -> hence more demand of goods & services -> hence price rise. This process continues till full employment is reached. The rise in price during this period is called semi inflation or bottleneck inflation.
      Hope this helps.

      1. Underemployment is not the same as disguised unemployment. If I have understood you right, do you mean to say that there is an increase in money circulation when there is underemployment?

    2. Dear paavana
      I have answered for your question to chandra.. have a look of it..
      it is an hypothetical proposition in the current world since the assumption of using excess money to employ unemployed resources , does not hold water . However its conceptual soundness can hardly add overemphasised

  5. Inflation

    1. Yes inflation is mostly a monetary phenomenon. But there are other factors which assists inflation namely political, social and natural factors.
    • Over expansion of money supply – Excess liquidity in the economy -this may be due to pay hike, easy availability of loans at lower interest rates, growing business opportunities etc.
    • Population growth – It gives rise to increase in demand and income. For example in India and China people are consuming more goods due to increased income and for better quality of life. Demand for those goods and services have led to high inflation.
    • An artificial demand in goods and services may be created by people in power and thus cause an increase in prices.
    • Increase in the prices of crude oil has subsequent effect on agriculture, transport and manufacturing industries which ultimately give rise to high prices
    • Natural disasters which causes scarcity in supply due to destruction caused to productions leads to high demand and hence inflation.

    2. Positive effects of inflation

    • High inflation tends to wipe out debt. Once the current inflation rate exceeds the interest rate on a loan or other debt, inflation is literally eating it away
    • Mild inflation causes the firms holding onto money to start lending. This lending capital causes interest rates to fall. This in turn makes availability of loans easier for further investment. This leads to faster growth and higher steady level of income.
    • Taxes may drop if inflation rises sharply, since no government wants inflation to become too rampant.
    • Economic recessions can be mitigated in the initial stages of inflation.
    • Finally the inflators are benefited.

    3. I feel that effects of inflation in underdeveloped counties having less than full employment is not a cause of worry. State of true inflation begins only after the level of full employment is reached. Employment will change in the same proportion as the quantity of money. So there is no need to fear because as long as there are unemployment and material resources, an increase in the quantity of money will not cause inflation. It will go on to increase more employment. After full employment is reached there needs to be concern on inflation.

    Please correct me on this as this is purely my logic. I may need more clarification on this.

  6. Dear Madame,

    Can you please explain what KEYNES quotes (in the first paragraph).
    “According to KEYNES, during the period of under employment, the increase in money supply leads to increase in aggregate demand output and employment.

    1. dear chandra
      Inflation is understood to occur when a quantum of money supply expands more than proportinately to the supply of goods in the market. However keynes slightly disagrees with this notion. According to him inflation starts only after the full employment is reached. To elaborate, keynes assumes that if money supply expands when there is still not full employment that is stillall men ana material are not put to use, sch expanded money shall be used to employ these unemployed resources, but not to purchase goods .Accorfding to keynes prices of goods shall not be raised in such a situation since the excess of money shall not vie for limited goods but is put to productive use. But even in that situation prices may rise because of factors other than the expansion of money supply , suh an inflation is bottleneck inflation

  7. Deflation

    1. Deflation is a state of economic disequilibrium caused due to a decline in the price levels (there are many other factors as well). Different sections of the society are affected differently in deflation. Some sectors benefit while the others suffer.
    • The producers and the traders are affected negatively as prices of finished goods are much less than the cost of production.
    • The consumers and salaried classes benefit in deflation as they get more value for money.
    • Creditors tend to gain and debtors tend to loose in deflation.
    • Banking sectors, private and public sectors loose out due to recession in the economy.
    • Small business may close down leading to large unemployment.
    • Pace of the economic growth slows down and hence economic, social and political life of the country gets disturbed.
    Hence from the above points there is unbalanced equilibrium in the economy due to deflation.

    2. Yes inflation in unjust and undeserved. When there is more liquidity in the economy, when there is more capital in the hands of the people the freedom to enjoy more goods and services are axed due to inflation. Hence people cannot enjoy a pay rise or loans at lower interest. On the other hand deflation reduces liquidity in the economy. Supply of money and credit is decreased. Economic activity contracts, output shrinks, new investment is curtailed and there is mass unemployment. Some people considered to be blessed due to deflation while others have a miserable life due to deflation. Thus deflation is impractical and inappropriate.

    Of the two evils deflation is the worst. Middle class people gain at the expense of the richer classes. Inflation though it redistributes income and wealth in the community in an unjust manner does not reduce the national income. Deflation reduces the national income and pauperizes society as a whole. Deflation increases the level of unemployment in the economy, whereas inflation at least implies that all factors are employed in some way or another. It is easy to control inflation through a clear money policy, coordinated by appropriate fiscal policy but it is difficult to recover from deflation. Reduction in output and widespread unemployment in deflation adversely affect the economic life of the country and lead to social unrest.

  8. Hi Ma’m

    I was reading an article of Dr. Subbarao, current governor of RBI that he proposes PPI ( Producer Price Index) for non-core inflation, which would measure the average change over time in the sale prices of domestic goods and services. Will this concept be able to work in Indian economic scenario,especially after implementation of GST ( Goods and Services Tax) . Kindly give your valuable feedback .


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