“Inflation” in simplest manner can be defined as a
chronic and sustained rise in prices caused by an
increase in money supply. In other wards, it is a
substantial rise in general price level, which causes
the decline in purchasing power of money .
According to Crowther, Inflation is a “state in which
the value of money is falling i.e. the prices are rising”.
According to Coulborn, Inflation is a situation where
“too much money chasing too few goods”.
However, every rise in prices is not leading to the
inflation. If a rise in price raises the profit margins of
the producer and induces larger volume of production,
this would be beneficial to the economy because after
some point of time prices will be falling as a result of
Hence, there are two types of rise in prices:
Rise in prices accompanied by increase in
• Rise in prices which does not increase production.
It is the second type of rise in prices which
leads to the inflationary situation in the economy.
Causes of Inflation:
(1) Increase in Money Supply: when the supply of
money in a country increases it is likely to lead rise in
price level. The Central bank of the country might print
more currency notes and put them into circulation to
tide over its budgetary deficits.
As this increased, money supply comes into
the hands of the public and they spends more of it.
This leads to an increase in the aggregate demand
and creates inflation in the country.
(2) Increase in the Volume of Credit: the supply of
money in the market also includes the amount of
credit created by the banks.
expansion in the bank credit will set in inflationary
pressure, while a credit contraction causes
depression in the economy. Very often inflation is
result of expansion in bank credit.
Classification of Inflation on the basis of Speed:
(1) Creeping inflation: it is the mildest form of inflation
and generally regarded as conducive to economic
development because it keeps the economy away
from the stagnation. Under the creeping inflation,
prices rise about 2 percent annually.
(2) Walking Inflation: under walking inflation, prices
rise about 5 percent annually.
(3) Running Inflation: under the running
inflation, prices rise about 10 percent
(4) Galloping Inflation or Hyper Inflation:
under this inflation price rises every moment
and there is no upper limit to the price rise.
Example: Hyper inflation in Germany after the
First World War and in China after the
Second World War.
The type of inflation can better be
explained by the help of a graphical
representation given below:
0 to A = Creeping Inflation (2%)
A to B = Walking Inflation (5%)
B to C = Running Inflation(10%)
C to D = Galloping Inflation/Hyper Inflation (>10%)
Theories of Inflation:
(1) Demand-Pull-Inflation : Demand-pull-inflation
occurs when the aggregate demand in the market
exceeds the volume of output available at the
market, which occurs due to the rise in general
price level. Thus, the demand-pull-inflation may be
defined as the situation where the aggregate
demand exceeds the economy’s ability to supply
the goods and services at the current prices.
(2) Cost-Push-Inflation: On the other hand, CostCost-Push-Inflation
push-inflation occurs when the price rise because
of the increase in factor prices without a
proportionate increase in their productivity. When
trade unions get a rise in wages, when the cost of
raw materials goes up, the cost of production will
be bound to rise and there by leading to a rise in
the price level.
Keynes in guide entitled “How to Pay for the War,
1940”, explained inflation in terms of inflationary gap.
According to him, inflationary gap occurs when, at full
employment level, aggregate demand exceeds
This suggests that due to increase in investment and
govt. expenditure, the money income increases but the
production does not increase due to the limitations of
the productive capacity.
As a result inflationary gap comes to exist causing the
prices to rise.
The price continues to rise so log as the inflationary gap
So, According to K.K. Kurihara, Inflationary gap is an
excess of anticipated expenditure over the availability of
Basically, the important cases of inflationary gap are
those associated with the govt. expenses on war
and war preparations.
Let us take the example of War time economy.
1. Total Money Income
2. Minus Taxes
GNP (pre-inflation prices)
Rs.100Cr. 2. Minus War Expenditure
3. Total Disposable Income Rs.900Cr
4 Minus Saving
5. Net Disposable Income
3. Available Output for Civilian
Inflationary Gap = Demand – Supply i.e. 800Cr. – 600Cr. = 200Cr.
This can also be represented by the help of a figure:
The above figure shows the graphic representation of
inflationary gap. Where
450 or Y=C+I+G is the equilibrium line which shows the
equality of total income and total expenditure.
C+I+G curve represents total expenditure comprising private
consumption (C), private investment (I) and govt.
The initial equilibrium of the economy is at point E0 which
represents full employment income OY0.
When expenditure increases from C+I+G to C’+I’+G’, the
new equilibrium will be at E1 representing higher money
The Available output (real Income) is OY0 or E0Y0 which is
less than the money income E1Y1 or OY1 by the vertical
Control of Inflation:
Broadly, the measures against inflation can
be divided into:
(1) Monetary Measures
(2) Fiscal measures
Monetary Measures: This is adopted by the monetary
authority or the central bank of a country to influence
the supply of money and credit by changing interest
rate structure and availability of credit.
(a) Increasing Bank rate: Bank rate is the rate at which
the central bank lends money to the commercial
banks. An increase in the bank rate will increase the
rate of interest charged by commercial banks, which
in turn, discourages borrowings by business man and
consumers. This will reduce money supply with public
and thus controls the inflation.
(2) Higher Reserve Ratio: An increase in the minimum
reserve ratio means that the member banks are required
to keep larger reserves with the central bank. This reduces
the deposit of the banks and thus limits their power to
create credit. So, restrictions on credit creation will control
(3) Consumer Credit Control: In developed and developing
countries, most of the consumer durable goods, such as,
T.V., Fridge, motorcycles etc. are purchased by the
consumers on installment credit.
During inflation, loan facilities for installment
buying are reduced to minimum to check the consumption
spending. This is done by:
(a) Raising initial payment
(b) Covering large number of goods on this category
(c) Reducing length of payment period.
Fiscal measures are the budgetary
measures of the government relating to taxes,
public expenditure etc. The major anti-inflationary
budgetary measures are:
(a) Increase in both direct and indirect taxes.
(b) Reduction in public expenditure
(c) Increasing public borrowings etc.