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What is inflation and Types of inflation, How does it affect our economy?

Updated on November 11, 2013

What is inflation

According to Pigou inflation takes place "when money income is expanding relatively to the output of work done by the productive agents for which it is the payment". At another place he says that "inflation exists when money income is expanding more than in proportion to income earning activity."

R. C. Hawtrey associates inflation with "the issue of too much currency". T. T Gregory calls it a state of "abnormal increase in the quantity of purchasing power". In general, inflation may be defined as a sustained rise in the general level of prices brought about by high rates of expansion in aggregate money supply.

All these definitions have a common feature. They stress the point that inflation is a process of rising price (and not a state of high prices) showing a state of disequilibrium between the aggregate supply and the aggregate demand at the current level of prices.

In other words, prices rise due to an increase in money supply compared to the supply of goods. This is quantity theory approach to prince change. However, any rise in price level should not be taken to mean inflation, as prices in a dynamic economy do rise on account of factors other than that mentioned above.

Keynes does not agree with the quantity theory approach that it is the volume of money that is responsible for price rise. According to Keynes, inflation is caused by an excess of effective demand, and the state of true inflation begins only after the level of full employment, employment will change in the same proportion as the quantity of money, and when there is full employment, prices will change in the same proportion as the quantity of money.

He believes that we do not unduly fear inflation because as long as there are unemployed human and material resources, an increase in quantity of money will go to increase employment. After full employment all increases in money supply will increase the price level. Keynes does not deny that prices may rise even before full employment but such a phenomenon he called as 'semi-inflation' or 'bottleneck inflation'.

Keynes introduced a new concept called the inflationary gap. The inflationary gap shows a situation in the economy when anticipated expenditures (demand0 exceed the available output (supply) at base prices or at the pre-inflation prices. Thus, the inflationary gap is measured by the difference between the disposable income on the one hand, and the output available for consumption on the other.

In other words, when on account of increased investment expenditure or government expenditure or both, money income rises, but due to limitations of the capacity to produce, the supply of goods and services does not increase in the same proportion, an inflationary gap emerges, giving fillip to rise in prices. It arises only when the total money income that people are keen to spend on the consumption exceeds the total output available at pre-inflation prices.

Features of inflation are as follows:

a) Inflation is always accompanied by rise in price and it is, in fact, uninterrupted increase in prices.

b) Inflation is essentially an economic phenomenon as it originates within the economic system and is fed by the action and interaction of economic forces.

c) Inflation is a dynamic process which can be observed more or less over a long period.

d) A cyclical movement should not be confused with inflation.

e) Inflation is a monetary phenomenon as it is generally caused by excessive money supply.

f) Pure inflation start after full-employment.

Types of Inflation

Inflation can be classified on the basis of different consideration.  On the basis of Degree of price rise can be classified as:

1.  Creeping Inflation
2.  Walking Inflation
3.  Running inflation
4.  Jumping or galloping or hyper-inflation

The most mild form of inflation is called creeping inflation.  Economists do not consider it to be dangerous for the economy.  However, some economists consider it to be important instrument of economic development and argue that it keep the national economy free from the effects of stagnation.  In some others view, creeping inflation may grow to hyper inflation so it is better to nip it in the bud.

Walking inflation is little more faster inflation than the creeping inflation.  It is treated as a signal for hyper inflation.  When the price rise happens in a faster rate, than walking inflation we can call it running inflation.  The highest rate of inflation is called jumping or galloping or hyper-inflation.

In hyper inflation, prices rise every moment and there is no limit to the highest to which the prices might rise.  Hyper inflation is an indication of the highest degree of abnormality in the monetary system of a country.  All assets (like salary, savings, bonds etc.) having fixed income lose their value under the hyper inflation.


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