2. DEFINITION
• An increase in the general level of prices in an
economy that is sustained over a period of time
is called inflation.
• When demand is more than the supply that may
lead to inflation.
3. Measuring Inflation
• Inflation is rate of change in the price level.
• If the price level in the current year is P1
and in the previous year P0.
• The inflation for the current year is
[(P1 - P0) / P0] x 100
4. TYPES OF INFLATION
1. Creeping Inflation
“When the rise in prices is very low like
that of a snail or creeper, is called
Creeping Inflation”
Here the inflation rate is upto 5%
The general level of prices rise at a
The general level of prices rise at a
moderate rate over a long period of time
5. 2. Running Inflation
Running inflation has inflation rate
between 8-10 %. A sense of urgency
needs to be shown in controlling the
running inflation.
Persistent running inflation reduces the
savings in the economy and results in
slowdown in economic growth.
6. 3. Hyper Inflation
Prices rise very fast at double or triple
digit rate.
Also called Runway or Galloping Inflations
This type of inflation is
witnessed in the past in many
countries.
Many Latin American countries
like Argentina and Brazil had
inflation rates of 50 to 700
percent per year in the 1970s
and 1980s.
Many developed and
industrialized countries like Italy
and Japan also witnessed the
hyper inflation in the past.
7. • 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.
8. CAUSES OF INFLATION
• Inflation is caused due to several economic factors:
• When the government of a country print money in excess, prices
increase to keep up with the increase in currency, leading to
inflation.
• Increase in production and labor costs, have a direct impact on
the price of the final product, resulting in inflation.
There are two main causes for inflation which is stated as below:
Demand Pull
Cost Push
9. Demand Pull:
This type of inflation happens when the
aggregate demand increases more than the
supply
Demands pull inflation, wherein the
economy demands more goods and services
than what is produced.
10. Demand Pull Inflation in AD-AS Graph
Y
AS
The reasons for the shift
in AD curve can be either P1
Price Level
real or monetary factors. P0
AD
It is due to: 1
AD
The real factors O
0
X
Y Y Y
The monetary 0 2 1
factors
11. Real Factors: The real factors can be increase or
decrease in the tax receipts and corresponding
increase or decrease in government expenditure.
Other factors are investment function, consumption
function and export function.
The monetary Factors: Monetary factors can be
increase or decrease in the money supply.
Example: In 1990s when Russian government
financed its budget deficit by printing
rubbles, the inflation rate per month
increased to 25 percent per month and the
annual inflation rate was 1355 percent.
12. Cost Push Inflation
When cost of production increases the
price level automatically increases.
Cost push inflation or supply shock
inflation, wherein non availability of a commodity
would lead to increase in prices
13. Cost Push Inflation in AD-AS Graph
Cost push theory of inflation explains the causes
of inflation origination from the supply side.
Cost push inflation depends on:
Y
◦ Wage push inflation AS1
◦ Profit push inflation AS0
◦ Supply shock inflation P1
Price Level
P0
AD
O Q Q X
1 0
Quantity
14. Demand pull vs Cost Push Inflation
• If demand pull inflation is correct the
government must bear the cost of excessive
spending and monetary authorities are to be
blamed for “cheap money policy”
• On the contrary, if cost push is the real cause
for inflation then the trade union are to blamed
for excessive wage claim, industries for
acceding them and business firms for marking-
up profits aggressively.
15.
16. Economic Impact of Inflation :
There is a wide spread impact of inflation on the
economies world over. The effect of inflation is felt
on distribution of income and wealth and on
production.
Effect of Inflation on the Distribution of Income and
Wealth:
The consumers stand at the loosing end, while the
producers having old inventories may gain from the
inflation.
People with fixed income group are the worst
sufferers of inflation.
17. • Inflation also results in black marketing.
Sellers may stock up the goods to be sold in
the future, anticipating further price rise.
• Inflation also discourages entrepreneurs in
investing as the risk involved in the future
production would be very high.
• Inflation also affects the pattern of
production, as the shift in production pattern
takes place from consumer goods to luxury
goods.
18. Measuring Inflation
Inflation is often measured either in terms of
Wholesale Price Index or in terms of Consumer Price
Index.
Wholesale Price Index(WPI) :
The Wholesale Price Index is an indicator designed to
measure the changes in the price levels of
commodities that flow into the wholesale trade
intermediaries.
The index is a vital guide in economic analysis and
policy formulation,
It is a basis for price adjustments in business
contracts and projects. It is also intended to serve as
an additional source of information for comparisons
on the international front.
19. Consumer Price Index (CPI) :
• Consumer price index is specific to particular group
in the population. It shows the cost of living of the
group.
• It is based on the changes in the retail prices of
goods or services. Based on their incomes, consumer
spends money on these particular set of goods and
services.
• There are different consumer price indices. Each
index tracks the changes in the retail prices for
different set of consumers. The reason for the
different indices is the differing pattern of
consumers.
20. • There are two broad ways in which governments
try to control inflation. These are-
• 1. Fiscal measures.
• 2. Monetary measures
21. Measures to control inflation
• Effective policies to control inflation need to focus on the
underlying causes of inflation in the economy.
Monetary Policy
• Monetary policy can control the growth of demand through an
increase in interest rates and a contraction in the real money
supply. For example, in the late 1980s, interest rates went up
to 15% because of the excessive growth in the economy and
contributed to the recession of the early 1990s.
• Monetary measures of controlling the inflation can be either
quantitative or qualitative. Bank rate policy, open market
operations and variable reserve ratio are the quantitative
measures of credit control, by which inflation can be brought
down. Qualitative control measures involve selective credit
control measures.
22. Bank rate policy is used as the main instrument of monetary control during the
period of inflation. When the central bank raises the bank rate, it is said to have
adopted a dear money policy. The increase in bank rate increases the cost of
borrowing which reduces commercial banks borrowing from the central bank.
Consequently, the flow of money from the commercial banks to the public gets
reduced. Therefore, inflation is controlled to the extent it is caused by the bank
credit.
Cash Reserve Ratio (CRR) : To control inflation, the central bank raises the CRR
which reduces the lending capacity of the commercial banks.
Consequently, flow of money from commercial banks to public decreases. In the
process, it halts the rise in prices to the extent it is caused by banks credits to
the public.
Open Market Operations: Open market operations refer to sale and purchase
of government securities and bonds by the central bank. To control
inflation, central bank sells the government securities to the public through the
banks. This results in transfer of a part of bank deposits to central bank account
and reduces credit creation capacity of the commercial banks.
23. Fiscal Policy:
• Higher direct taxes (causing a fall in disposable income)
• Lower Government spending
• A reduction in the amount the government sector borrows each
year (PSNCR)
Direct wage controls - incomes policies
Incomes policies (or direct wage controls) set limits on the rate of
growth of wages and have the potential to reduce cost inflation.
• Government can curb it’s expenditure to bring the
inflation in control.
• The government can also take some protectionist
measures (such as banning the export of essential
items such as pulses, cereals and oils to support the
domestic consumption, encourage imports by
lowering duties on import items etc.).
