Meaning of Inflation
The price of goods and services are always changing. The chocolate one could buy for $1 a year back now costs $1.5. This is because of the increase in the price of commodities.
The phenomena when the prices of goods and services rise is known as inflation. It was first brought into light by the neo-classical economists, after which it has undergone modifications and it still remains a debatable term even today.
Neo-classical economists defined inflation as increase in price level of commodities. They believed that the economy is always at full employment, which means that all the available resources are fully utilized to meet the demand of the economy. Thus, inflation was a result of extra flow of money within the economy.
However, Keynes opposed to the neo-classical view of inflation. He stated since unemployment exists in the economy, the excess supply of money leads to a rise in total demand, output and employment. As the money supply increase, the level of output increase at the same level. But, when there is further rise in total demand, output, and employment, price of commodities start rising further. This happens because of the effect of diminishing returns.
The prices that rise until the level of full employment is termed as semi-inflation. When the money supply increases even after full employment has been attained, output remains same, and only the prices rise.
Thus, inflation is defined as a state of continuous rise in general price of all commodities. Specifically, it is a situation of rising prices in which a unit of money will buy less quantity of goods and services. This means that with the rise in the supply of money, the price of commodities increase, while the purchasing power of money decreases.
According to Arthur Cecil Pigou, inflation takes place ‘when money is expanding relatively to the output of work done by the productive agents for which it is the payment’.
John Maynard Keynes defines, ‘Inflation is the result if excess aggregate demand over the aggregate supply and the true inflation starts after full employment.’ According to him, the rise in price level before full employment is semi-inflation.
On the basis of the scholarly definitions provided by various economists, inflation can be stated as a continuous rise in price levels of most goods and services during which the quantity of money increases but the value of money decreases.
Types of Inflation
The types of inflation have been classified on the basis of their varying nature. Generally, the basis of its classification is the rate of speed, cause, government reaction, and employment levels.
I. On the basis of speed
The different types of inflation on the basis of speed are explained below:
When the rise in price level is less than 3 percent per annum, it is termed as creeping or mild inflation. The price of goods and services rise moderately and it is usually considered helpful for the development of the economy. However, some economists consider it as a signal towards the rising prices.
A sustainable rise in price level within the range of 3 percent to 6 percent or less than 10 percent is called as walking inflation. It occurs when mild inflation is not considered or is let to fan out by the government.
Both creeping inflation and walking inflation are one digit figures and are considered as moderate inflation in the economy.
When the rise in prices increase rapidly at a rate of 10 percent or 20 percent per annum is known as running inflation. As the inflation rate crosses two digit figure, economic problems arise. Running inflation adversely affects the poor and middle class families and households in the economy.
Hyperinflation or galloping inflation is a rise in price level by 50 percent or more annually. It occurs when running inflation is left uncontrolled in the economy. When the economy faces hyperinflation, the preference of people shift from money to the traditional barter system.
For instance, between 2007 and 2009, Zimbabwe faced severe economic problems due to political changes and harsh climatic conditions. As a solution to this, the leaders of the country printed billions of money, which led the country into hyperinflation. The rate of inflation reached 79 billion% per month.
II. On the basis of employment level
The rise in general price level below the level of full employment is termed as semi-inflation. According to Keynes, general prices do not rise as long as there are unemployed resources in the economy. However, when aggregate expenditure increases by a large portion, costs for some resources may rise eventually leading to increase in price. This phenomena is known as semi-inflation.
The inflation that occurs when the economy is at full employment level is known as pure inflation. As Keynes states, at full employment levels, output cannot be increased any further. Due to this, price level rises in relation to the rise in demand for commodities. This is termed as pure inflation.
III. On the basis of government reaction
When the government has no control over the price rise and there are no barriers to price rise, it is termed as open inflation. In this case, markets for commodities or factors or production are allowed to function freely with no intervention from the central authority.
When the government makes efforts to check the price rise through price control mechanisms, it is called as suppressed inflation. The government imposes various physical and monetary controls in order to suppress the extensive increase in price levels. Although control over price rise helps to keep inflation under check, it leads to price rise in uncontrolled resources, consequently resulting in diversion of productive resources. It may also lead to economic problems like hoarding of goods, black marketing, corruption, and so on.
IV. On the basis of cause
Demand pull inflation
The rise in price due to excess demand for goods and commodities in comparison to their supply is termed as demand pull inflation. Classical economists state that the reason behind the rise in demand is because of the increased supply of money.
Cost push inflation
The rise in the price level as a result of increase in the cost involved in the production of goods and services in known as cost push inflation. Cost of production may be caused due to the rise in price of raw materials, wages of workers, and so on.
For instance, the cost bread that costs $1 has risen to $1.5 in a month. This may have occurred because of the increase in the price of wheat or because of the higher wages demanded by workers in a baking company.
An economy faces deficit balance when its expenditures exceed revenue. In order to meet the gap, the government prints more money through central bank. So, any price rise in the economy due to the government’s effort to level of the deficit balance is called as deficit-induced inflation.
When financial institutions and commercial banks provide more loan to the public with a view to earn more profit, the amount of money in the economy exceeds more than what is required. The expansion of credit leads to rise in price level and is termed as credit inflation.