Inflation: Definitions, Kinds, and Causes of Inflation

Two concepts (Demand of money and Supply of money) play a crucial role in the functioning of an economy.

An imbalance in any of these two functions can cause discrepancies in the whole functioning of an economy.

“The word inflation in the broadest possible sense refers to any increase in the general price-level which is sustained and non-seasonal in character”-Peterson.

 

Consequently, there is an increase in the general level of prices of goods and services over a given period of time. A persistent increase in the general price levels of goods and services is known as inflation.

Some of the popular definitions of inflation given by different management gurus are as follows:

According to Coulborn inflation can be defined as, “too much money chasing too few goods.”

According to Parkin and Bade, “Inflation is an upward movement in the average level of prices. Its opposite is deflation, a downward movement in the average level of prices. The boundary between inflation and deflation is price stability.”

According to Samuleson-Nordhaus, “Inflation is a rise in the general level of prices.”

In the words of Peterson, “The word inflation in the broadest possible sense refers to any increase in the general price-level which is sustained and non-seasonal in character.”

As per Johnson, “Inflation is an increase in the quantity of money faster than real national output is expanding.”

Keynes has presented his view that true inflation is the one in which the elasticity of supply of output is zero in response to increase in supply of money. In other words, there is no change in supply of output when the supply of money increases, which is a case of full employment.

In case of full employment, the situation would not be inflationary. However, we do not rely on classical view of full employment. Therefore, when the supply of money increases then the output and price also increase. In case, the rise in prices exceeds the rise in output, then the situation is termed as inflationary situation.

Kinds of Inflation:

Inflation is usually categorized on the basis of its rate and causes. Here, we would study the types of inflation based on its rate.

Broadly, inflation can be of three types based on its rate, which are as follows:

(a) Moderate Inflation:

Takes place when the prices of goods and services rise at a single digit rate annually. Moderate inflation is also termed as creeping inflation. When an economy passes through moderate inflation, the prices of goods and services increase but at moderate rate.

However, the rate of increase in prices under this type of inflation varies from country to country. Moderate inflation is a type of inflation that can be anticipated; therefore, individuals hold money as a store of value.

(b) Galloping Inflation:

Refers to a type of inflation that occurs when the prices of goods and services increase at two-digit or three-digit rate per annum. Galloping inflation is also known as jumping inflation. In the words of Baumol and Blinder, “Galloping inflation refers to an inflation that proceeds at an exceptionally high.”

Galloping inflation has adverse effect on middle and low income groups in the society. As a result, individuals are not able to save money for future. This kind of situation requires strict measures to control inflation.

(c) Hyperinflation:

Occurs when the rate of increase in prices is extremely high or out of control. In other words, hyperinflation takes place when the increase in prices is more than three-digit rate annually. Hyperinflation takes place when there is an unrestricted increase in the supply of money in the market.

This leads to a situation of imbalance in the supply and demand of money. Consequently, money loses its real worth at a rapid rate, which, in turn, leads to an increase in prices. The economic condition of Germany in 1922 and 1923 is the best example of hyperinflation. Apart from this, in 1989 and 1991, Argentina, Brazil, and Zimbabwe were also striving hard to overcome hyperinflation.

Causes of Inflation:

Generally, inflation takes place in an economy when demand for goods and services exceeds the supply of output. Therefore, causes of inflation have two sides, the demand side and supply side.

The various causes of inflation are as follows:

(a) Increase in demand:

Takes place due to the following factors:

i. Increase in money supply

ii. Increase in disposable income

iii. Increase in expenditure on investment and consumption goods

iv. Increase profit-making capacity of producers and retailers

v. Increase in foreign demand and exports

vi. Increase in population

The aforementioned causes of inflation may work alone or in combination with each other. The main cause of inflation is the excessive government spending on economic growth and developmental plans. This causes increase in money supply in the market As a result, the disposable income of individual’s increases, which, in turn, increases their purchasing power.

(b) Constant supply of output:

Occurs due to the following factors:

i. Lack of capital equipment

ii. Lack of factors of production, such as trained labor, raw materials, and inefficient management

iii. Increase in exports to get foreign currency

iv. Decrease in imports due to various reasons, such as war or restriction on imports

v. Increase in restrictive trade practices to get advantage from rise in price in future

vi. Prolonged industrial unrest.