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Inflation & deflation


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Inflation & deflation

  1. 1. Inflation & Deflation
  2. 2. • Meaning of Inflation In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time. When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a loss of real value in the internal medium of exchange and unit of account in the economy. A chief measure of price inflation is the inflation rate, the annualized percentage change in a general price index (normally the Consumer Price Index) over time.
  3. 3. Effects of Inflation • Inflation's effects on an economy are various and can be simultaneously positive and negative. Negative effects of inflation include a decrease in the real value of money and other monetary items over time, uncertainty over future inflation may discourage investment and savings, and high inflation may lead to shortages of goods if consumers begin hoarding out of concern that prices will increase in the future. Positive effects include ensuring central banks can adjust nominal interest rates (intended to mitigate recessions),and encouraging investment in non-monetary capital projects.
  4. 4. • High Inflation :Economists generally agree that high rates of inflation and hyperinflation are caused by an excessive growth of the money supply. • Low or moderate inflation may be attributed to fluctuations in real demand for goods and services, or changes in available supplies such as during scarcities, as well as to growth in the money supply. • Long period of sustained inflation is caused by money supply growing faster than the rate of economic growth.
  5. 5. Types of Inflation • There are four main types of inflation. Wage Inflation: Wage inflation is also called as demand-pull or excess demand inflation. This type of inflation occurs when total demand for goods and services in an economy exceeds the supply of the same. When the supply is less, the prices of these goods and services would rise, leading to a situation called as demand-pull inflation. This type of inflation affects the market economy adversely during the wartime. Cost-push Inflation: As the name suggests, if there is increase in the cost of production of goods and services, there is likely to be a forceful increase in the prices of finished goods and services. For instance, a rise in the wages of laborers would raise the unit costs of production and this would lead to rise in prices for the related end product. This type of inflation may or may not occur in conjunction with demand-pull inflation.
  6. 6. Demand-Pull Inflation/ Wage Inflation
  7. 7. Cost- Push Inflation
  8. 8. • Pricing Power Inflation: Pricing power inflation is more often called as administered price inflation. This type of inflation occurs when the business houses and industries decide to increase the price of their respective goods and services to increase their profit margins. A point noteworthy is pricing power inflation does not occur at the time of financial crises and economic depression, or when there is a downturn in the economy. This type of inflation is also called as oligopolistic inflation because oligopolies have the power of pricing their goods and services.
  9. 9. • Sectoral Inflation: This is the fourth major type of inflation. The sectoral inflation takes place when there is an increase in the price of the goods and services produced by a certain sector of industries. For instance, an increase in the cost of crude oil would directly affect all the other sectors, which are directly related to the oil industry. Thus, the ever- increasing price of fuel has become an important issue related to the economy all over the world. Take the example of aviation industry. When the price of oil increases, the ticket fares would also go up. This would lead to a widespread inflation throughout the economy, even though it had originated in one basic sector. If this situation occurs when there is a recession in the economy, there would be layoffs and it would adversely affect the work force and the economy in turn.
  10. 10. • Other Types of Inflation Fiscal Inflation: Fiscal Inflation occurs when there is excess government spending. This occurs when there is a deficit budget. For instance,. America is also facing fiscal type of inflation under the presidentship of George W. Bush due to excess spending in the defense sector. Hyperinflation: Hyperinflation is also known as runaway inflation or galloping inflation. This type of inflation occurs during or soon after a war. This can usually lead to the complete breakdown of a country’s monetary system. However, this type of inflation is short-lived. To sum up, any type of inflation could affect the economy of a country badly. •
  11. 11. Hyper-Inflation
  12. 12. Measures to Control Inflation • Given that inflation shows the imbalance between supply and demand of goods at current prices so that measures be taken to reduce demand or increase supply of goods and services. The supply side Measures • Increased Production The supply of goods and services can be increased by increasing agricultural and industrial production. Agricultural production can be increased by providing an adequate supply of agricultural inputs at low prices, the modernization of agriculture and scientific farm management, adequate water supply for irrigation, industrial production etc similarly can be increased by increased foreign direct investment, industrial credit growth, fiscal concessions, etc.
  13. 13. • Control of illegal Activities There are some illegal activities that cause significant inflation in a country. It is hoarding, smuggling, profiteering, black markets, etc. In the case of smuggling of large quantities of staples like sugar, butter, wheat, rice, etc are exported abroad illegally in order to obtain higher prices. Similarly, the shortage in most cases artificial staples to create higher profits. All activities of this evil must be controlled through advertising, as well as punishment. • Peace and Security Production and distribution of goods and services can be effected due to the existence of disturbances and insecurity in society. In such circumstances, investors hesitant to invest for fear of potential loss. Similarly, the production of industrial products is affected due to several unpleasant events such as strikes ,therefore peace and security must be ensured to maintain the supply of goods and avoid the danger of famine.
  14. 14. • Main Energy Sources The supply of agricultural and industrial products is highly dependent on energy availability. If the energy source is expensive, the cost of production of goods and services will be expensive too. Increased production costs raise prices and cause inflation. Therefore all necessary measures be taken to provide major sources of energy in industrial and agricultural sectors of the economy
  15. 15. The demand side • Control of Money Supply The money supply has a great influence on the rising inflation that is, inflation with increasing the money supply and vice versa. Therefore, to control inflation, measures must be taken to control the money supply. The money supply can be controlled with the help of monetary policy in which the central bank uses various methods, such as bank rate policy, open market operations, changes in reserve requirements, credit rationing , direct action etc. All these methods are useful to control the rate of inflation in a country.
  16. 16. • Population Control In most developing countries, the population is increasing very quickly that the production of goods and services does not increase at the same pace. Because the imbalance between supply and demand of goods and services are produced and cause inflation. Therefore, to control inflation, appropriate measures should be taken to control the population. • Fiscal Policy Fiscal policy refers to government policy of public spending and taxes. The main fiscal policy objective is to maintain only the slight change in the general price level. During inflation, the government tries to reduce its expenditure on unproductive activities and the direct tax rate increases so that the purchasing power of the population is reduced. Due to the reduction in the purchase of the population, demand for goods and services will be reduced and controlled inflation.
  17. 17. There should be no Deficit Financing Deficit financing shows that public spending beyond their income. The purpose of deficit financing is to meet the additional costs that the budget deficit. Because the money supply increases in the country and causes inflation. Therefore the deficit financing should be discouraged and all development costs must be met through taxes and debt. Direct Measures • There are several other options available to the government to control inflation and wage and price freeze, the rationing of goods, establishment of public service shops, the price review committees, boards of price stabilization, etc. This direct measures are often used by the government to control inflation.
  18. 18. Deflation It refers to continuous fall in price level. This happens in recession period. If it last for longer period, it harms the growth & development of the economy. The Government should adopt policies which are similar to the situation of recession. Eg. • Increase income by reducing taxes • Generate employment • Adopt policies which enhance production