Inflation means a persistent rise in the price levels of commodities and services, leading to a fall in the
currency’s purchasing power. The problem of inflation used to be confined to national boundaries, and was caused by domestic money
supply and price rises. In this era of globalization, the effect of economic inflation crosses borders and percolates to both
developing and developed nations.
Central bankers believe that mild inflation, in the 1 to 2 per cent range, is the most benign for a country’s economy. High
inflation, stagflation or deflation are all considered to be serious economic threats.
Causes of Economic Inflation
The following factors can lead to inflation:
- Printing too much money. This is called a loose or expansionary monetary policy. If there is a lot of money going around,
then supply is plentiful compared to the products you can buy with that money. The law of supply and demand therefore dictates
that prices will rise.
- Increases in production costs.
- Tax rises.
- Declines in exchange rates.
- Decreases in the availability of limited resources such as food or oil.
- War or other events causing instability.
Economists generally believe that money supply is the key cause of inflation; in 2008, however, skyrocketing prices of oil,
food and steel caused runaway levels of inflation in the world economy that collapsed only because of the global Financial
Crisis.
Economic Effects of Inflation
One of the economic effects of inflation is the change in the marginal cost of producing money. This involves the appropriate
'price' of money which, in this case, is the nominal rate of interest. This 'price' indicates the return which has to be
pre-determined to hold back the printing presses, in place of some other assets which offer the market interest rate.
In addition, if a country has a higher rate of inflation than other countries, its balance of trade is likely to move in an
unfavorable direction. This is because there is a decline in its price competitiveness in the global market.
A high rate of inflation can cause the following economic impediments:
- The value of investments are destroyed over time.
- It is economically disastrous for lenders.
- Arbitrary governmental control of the economy to control inflation can restrain economic development of the country.
- Non-uniform inflation can lead to heavy competition in the global market and threaten the existence of small economies.
- High levels of inflation tend to lead to economic stagnation.
Measures to Control Inflation
The central banks, monetary authorities or finance ministries of most nations have the authority to take economic measures to
control rising inflation by regulating the following factors:
- Reducing the central bank interest rates and increasing bank interest rates.
- Regulating fixed exchange rates of the domestic currency.
- Controlling prices and wages.
- Providing cost of living allowance to citizens in order to create demand in the market.
Different schools of thought emphasize different factors as the root cause of inflation. However, there is a consensus on the
view that economic inflation is caused either by an increase in the money supply or a decrease in the quantity of goods being
supplied, and that the effects of either high inflation or deflation are extremely damaging to the economy.