Causes And Effects Of Inflation Pdf

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Inflation is often defined in terms of its supposed causes. Inflation exists when money supply exceeds available goods and services.

I was asked to speak on the causes of and remedies for inflation in Australia. The first point that I want to make is both very simple and very important. Your committee, in asking me to speak on the causes plural of and remedies plural for inflation in Australia, embodied this point in their request.

What Is Inflation (Definition) – Causes & Effects of Rate on Prices & Interest

Inflation is a highly controversial term which has undergone modification since it was first defined by the neo-classical economists. They meant by it a galloping rise in prices as a result of the excessive increase in the quantity of money. He did not believe like the neo-classicists that there was always full employment in the economy which resulted in hyper-inflation with increases in the quantity of money. According to him, there being underemployment in the economy, an increase in the money supply leads to increase in aggregate demand, output and employment.

Starting from a depression, as the money supply increases, output at first rises proportionately. This process continues till the full employment level is reached. This is true inflation, according to Keynes. First, it lays emphasis on demand as the cause of inflation, and neglects the cost side of inflation. Second, it ignores the possibility that a price rise may lead to further increase in aggregate demand which may, in turn, lead to further rise in prices.

However, the types of inflation during the Second World War, in the immediate post-war period, till the middle of the s were on the Keynesian model based on his theory of excess demand. But before we analyse them, it is instructive to know about the meaning of inflation. To the neo-classical and their followers at the University of Chicago, inflation is fundamentally a monetary phenomenon.

Accordingly, different names have been given to inflation depending upon the rate of rise in prices. When the rise in prices is very slow like that of a snail or creeper, it is called creeping inflation. In terms of speed, a sustained rise in prices of annual increase of less than 3 per cent per annum is characterised as creeping inflation. Such an increase in prices is regarded safe and essential for economic growth.

When prices rise moderately and the annual inflation rate is a single digit. In other words, the rate of rise in prices is in the intermediate range of 3 to 6 per cent per annum or less than 10 per cent. Inflation at this rate is a warning signal for the government to control it before it turns into running inflation.

When prices rise rapidly like the running of a horse at a rate or speed of 10 to 20 per cent per annum, it is called running inflation. Such an inflation affects the poor and middle classes adversely. Its control requires strong monetary and fiscal measures, otherwise it leads to hyperinflation.

When prices rise very fast at double or triple digit rates from more than 20 to per cent per annum or more, it is usually called runaway ox galloping inflation. It is also characterised as hyperinflation by certain economists.

Prices rise many times every day. The speed with which prices tend to rise is illustrated in Figure 1.

The curve W depicts walking inflation when the price level rises by more than 50 per cent during ten years. The curve R illustrates running inflation showing a rise of about per cent in ten years. The steep curve H shows the path of hyperinflation when prices rise by more than per cent in less than one year.

According to Keynes, so long as there are unemployed resources, the general price level will not rise as output increases. But a large increase in aggregate expenditure will face shortages of supplies of some factors which may not be substitutable.

This may lead to increase in costs, and prices start rising. This is known as semi-inflation or bottleneck inflation because of the bottlenecks in supplies of some factors. According to Keynes, when the economy reaches the level of full employment, any increase in aggregate expenditure will raise the price level in the same proportion. This is because it is not possible to increase the supply of factors of production and hence of output after the level of full employment.

This is called true inflation. Employment and price level are taken on vertical axis and aggregate expenditure on horizontal axis. FE is the full employment curve. When with the increase in aggregate expenditure, the price level rises slowly from A to the full employment level B, this is semi-inflation.

This is true inflation. Thus open inflation is the result of the uninterrupted operation of the market mechanism. There are no checks or controls on the distribution of commodities by the government. Increase in demand and shortage of supplies persist which tend to lead to open inflation. Unchecked open inflation ultimately leads to hyperinflation.

Men the government imposes physical and monetary controls to check open inflation, it is known as repressed or suppressed inflation. The market mechanism is not allowed to function normally by the use of licensing, price controls and rationing in order to suppress extensive rise in prices. So long as such controls exist, the present demand is postponed and there is diversion of demand from controlled to uncontrolled commodities. But as soon as these controls are removed, there is open inflation.

Moreover, suppressed inflation adversely affects the economy. When the distribution of commodities is controlled, the prices of uncontrolled commodities rise very high. Controlled distribution of goods also leads to mal-allocation of resources. This results in the diversion of productive resources from essential to non-essential industries.

Lastly, suppressed inflation leads to black marketing, corruption, hoarding and profiteering. Stagflation is a new term which has been added to economic literature in the s. Stagflation is a situation when recession is accompanied by a high rate of inflation. It is, therefore, also called inflationary recession.

The principal cause of this phenomenon has been excessive demand in commodity markets, thereby causing prices to rise, and at the same time the demand for labour is deficient, thereby creating unemployment in the economy. Three factors have been responsible for the existence of stagflation in the advanced countries since First, rise in oil prices and other commodity prices along with adverse changes in the terms of trade, second, the steady and substantial growth of the labour force; and third, rigidities in the wage structure due to strong trade unions.

The concept of mark-up inflation is closely related to the price-push problem. Modem labour organisations possess substantial monopoly power. They, therefore, set prices and wages on the basis of mark-up over costs and relative incomes.

Firms possessing monopoly power have control over the prices charged by them. So they have administered prices which increase their profit margin. This sets off an inflationary rise in prices. A ratchet is a toothed wheel provided with a catch that prevents the ratchet wheel from moving backward.

The same is the case under ratchet inflation when despite downward pressures in the economy, prices do not fall. In an economy having price, wage and cost inflations, aggregate demand falls below full employment level due to the deficiency of demand in some sectors of the economy. But wage, cost and price structures are inflexible downward because large business firms and labour organisations possess monopoly power.

Consequently, the fall in demand may not lower prices significantly. But it leads to a general price rise because prices do not fall in the deficient demand sectors.

Is a situation when prices are raised deliberately in order to encourage economic activity. This is called reflation. Its earliest explanation is to be found in the simple quantity theory of money. The theory states that prices rise in proportion to the increase in the money supply. Given the full employment level of output, doubling the money supply will double the price level. So inflation proceeds at the same rate at which the money supply expands.

In this analysis, the aggregate supply is assumed to be fixed and there is always full employment in the economy. Naturally, when the money supply increases it creates more demand for goods but the supply of goods cannot be increased due to the full employment of resources.

This leads to rise in prices. The higher the growth rate of the nominal money supply, the higher the rate of inflation. When the money supply increases, people spend more in relation to the available supply of goods and services. This bids prices up. Modem quantity theorists neither assume full employment as a normal situation nor a stable velocity of money. Still they regard inflation as the result of excessive increase in the money supply.

The initial full employment situation OY F at this price level is shown by the interaction of these curves at point E. Now with the increase in the quantity of money, the aggregate demand increase which shifts the demand curve D to D 1 to the right. The aggregate supply being fixed, as shown by the vertical portion of the supply curve SS 1 the D 1 curve intersects it at point E 1.

This raises the price level to OP 1. The Keynesian theory of demand -pull inflation is explained diagrammatically in Figure 3. The price level is OP. Now the government increases its expenditure. This tends to raise the price level to OP 1 , as aggregate supply of output cannot be increased after the full employment level. This type of inflation has not been a new phenomenon and was found even during the medieval period.

But it was revived in the s and again in the s as the principal cause of inflation. Cost-push inflation is caused by wage-push and profit-push to prices for the following reasons:. The basis cause of cost-push inflation is the rise in money wages more rapidly than the productivity of labour.

In advanced countries, trade unions are very powerful. They press employers to grant wage increases considerably in excess of increases in the productivity of labour, thereby raising the cost of production of commodities.

Inflation in Australia: Causes and Cures

This is a great question! Inflation rates and speculation about future inflation are mentioned so often in the media that it's important to know some basics about inflation. What is inflation? Inflation is defined as a rise in the general price level. In other words, prices of many goods and services such as housing, apparel, food, transportation, and fuel must be increasing in order for inflation to occur in the overall economy. If prices of just a few types of goods or services are rising, there isn't necessarily inflation.

Both are responsible for a general rise in prices in an economy. But they work differently. Demand-pull conditions occur when demand from consumers pulls prices up. Cost-push occurs when supply cost force prices higher. You may find some sources that cite a third cause of inflation, expansion of the money supply. The Federal Reserve explains that it's a type of demand-pull inflation, not a separate cause of its own. Producers can't make enough to meet demand.

Inflation means there is a sustained increase in the price level. The main causes of inflation are either excess aggregate demand AD economic growth too fast or cost push factors supply-side factors. If the economy is at or close to full employment, then an increase in aggregate demand AD leads to an increase in the price level PL. As firms reach full capacity, they respond by putting up prices leading to inflation. Also, near full employment with labour shortages, workers can get higher wages which increase their spending power. We tend to get demand-pull inflation if economic growth is above the long-run trend rate of growth. The long-run trend rate of economic growth is the average sustainable rate of growth and is determined by the growth in productivity.


This PDF is a selection from an out-of-print volume from the National. Bureau of Economic Research. Volume Title: Inflation: Causes and Effects. Volume.


What Is Inflation (Definition) – Causes & Effects of Rate on Prices & Interest

Inflation is an economic term describing the sustained increase in prices of goods and services within a period. To some, it signifies a struggling economy, whereas others see it as a sign of a prospering economy. Here, we examine some of the residual effects of inflation.

Inflation is a highly controversial term which has undergone modification since it was first defined by the neo-classical economists. They meant by it a galloping rise in prices as a result of the excessive increase in the quantity of money. He did not believe like the neo-classicists that there was always full employment in the economy which resulted in hyper-inflation with increases in the quantity of money.

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