Inflation: Introduction and Types

By | April 9, 2020

Inflation is a quantitative measure which ascertains the average price level of various goods and commodities increase in an economy. It is a persistent situation with an increase in price. When the prices of commodities begin to rise, the purchasing power of rupee 1 starts falling. Hence, inflation causes a decrease in the purchasing power of the economy.

According to Keynes, ‘There is no change in the supply of output when the supply of money increases, which is a cause of full employment.’

According to Peterson, ‘The world inflation in the broadest possible sense refers to any increase in the general price level, which is sustained and non-seasonal in character.’

According to Coulborn, ‘Too much money chasing too few goods.’

Inflation is caused because of the following factors:

Consumer confidence: With stable wages and low unemployment, consumers are confident in spending the money on consumption as compared to investment. The sellers sell highly demanded goods at an increased price which result in inflation. It is known as demand-pull inflation.

Supply shocks: When the aggregate supply of the economy is adversely affected, then it results in lower production of goods and services. Increased demand and reduced supply led to higher prices.

Decisions of Corporates: Renowned companies giving popular products and services gradually increase their prices as they know customers are willing to pay higher charges.  The also increase the price of necessary goods such as oil and gas, as they are unavoidable. It is also known as cost-push inflation.

Types of Inflation:

On the basis of the speed of rising in prices, inflation is categorised into four categories:

Creep inflation:

It is the situation when the economy faces a gradual but continuous increase in the price levels, over the period of time. It has very small effect on short-term, but when it is analysed for a longer period, then it increases the cost of living significantly.

Walking inflation:

It is also known as trotting inflation. The price rise moderate and the inflation rate remains a single digit, i.e. 3-9% for the entire year. It gives the government and economists warning to curb the inflation rate before it transforms into galloping inflation.

Galloping inflation: When the increase in the price of goods and services is at double-digit or triple-digit for a year, then such inflation is termed as galloping inflation. This leads to various economic disturbances and distortions.

It generally affects the middle and lower-income groups. It is also known as jumping inflation. There are no savings for middle-level groups.

Hyper inflation:

It is a scenario when the rise in inflation is more than three-digit. It is an out of control situation. It occurs because there are no restrictions placed on the money supply. There is an unlimited increase in money supply in the economy. It generally occurs when the government prints money to finance wars and is rarely faced by countries or when there is a condition of depression. Under depression, there is an increase in money supply with minimal or no increase in GDP. Thus, there is lesser supply and more demand which leads to rocketing prices.

The money loses its real value and the prices of the commodities increase. E.g. Germany 1922, Brazil and Argentina 1989.

Other types of inflation are presented below:

Stagflation:

It is a scenario when the company faces slower growth, stagnation in economic activities, high unemployment along with inflation or rising prices. The GDP declines while the prices of commodities keep on rising. It is called an unnatural occurrence because when the individuals are unemployed, there is lesser spending; hence, because of lesser demand, the price of goods should not rise. e.g. US 1970.

It occurs because of supply shocks or the government’s measures. Supply shock means an unfavourable situation that affects the supply of commodities. e.g. a sudden increase in oil prices. Under this, the economy slows down but prices of oil tend to increase. When the government formulates policies that increase the money supply but damage the industries, then also there is economic slow down with increasing prices. This inflation is difficult to be curbed because if the government formulates policy for reducing inflation, then it add to unemployment and if the government focuses on tackling unemployment, there is the rise in prices, i.e. inflation.

Core inflation:

The temporary or transitory price volatility is excluded while measuring core inflation. Some of the energy products or food items face high price volatilities. It helps in learning fundamental long term inflation. Food and energy products are kept outside the purview of such inflation because their demand is not affected by their prices as they are necessary goods. Hence, they are ignored while calculating core inflation.

This inflation is calculated on the premise that if temporary shocks are considered, then the overall inflation rate cannot be estimated correctly. It also helps in understanding the relationship between the price of consumer’s income and the price of goods and services.

Thus, it is calculated to ascertain the actual inflation rate while eliminating the possibilities of volatility and shocks. It generally based on core Personal Consumption Expenditures (PCE) and Consumer Price Index (CPI), along with outliers method. Outlier’s methods exclude those commodities that have seen enormous price changes.

Wage inflation:

When the corporates pay high wages, they increase the price of the products in order to maintain corporate profits. Hence, the prices charged for the product increase because of ‘wage push’. The increased price/cost of services and goods has a cyclical impact on wage increase. Corporates increase minimum wage levels due to the number of factors, among which government’s policies is the most significant. Other factors include demand from trade unions, search for competent labour or when there is a shortage of workers. Thus, to pay increased wages, the corporates increase the prices of the product, which results in inflation. Hence, this inflation is pushed by an increase in wages.

Disinflation:

Disinflation is s phenomenon which occurs when the rate of inflation starts decreasing. Hence, there is an increase in the general price level, but there is an decrease in the rate. It is prevalent when there is a slow down in the increase in the price level from the previous period.

It is caused when there is slow economic growth in money supply or when there is recession in the economy. Supply of money reduces due to strict monetary policies of the government, leading to fall in demand of commodities and services.

If the inflation rate was 5% in the previous year and it is 3% in the current year, then there is disinflation of 2%. Thus, the rate has decreased, but there is an increase in the prices of commodities, i.e. by 3% e.g. Japan.

Deflation:

When the prices of the commodities, goods and services experience a general deadline, it is called deflation. The inflation rate goes below 0%. When the money supply becomes fixed and then it results in deflation. The purchasing power of the economy is higher in deflation. Thus, a fall in the money supply is the primary cause of deflation. Thus, a fall in the money supply is the primary cause of relation. It is also caused by increased productivity and fall in aggregate demand. As technology advances, productivity increases the cost of production increases. Thus, this benefit is passed on to the customers in the form of a reduced price of the products. Hence, deflation occurs. When the aggregate demand falls, the prices of the commodity also falls, leading to deflation. When the monetary policy is tightened, then the interest rates are increased. This includes people to save money rather than spending on commodities. Hence, the aggregate demand falls and prices come down.