Classical Theory of Inflation says that money is the asset which is utilized by people to purchase goods and services on a regular basis. Money is the mode of exchange in every economy at the present day. Inflation occurs in an economy when the overall price level increases and the demand of goods and services increases.
There is another aspect of inflation which is coined as hyperinflation. Hyperinflation is another form of inflation which occurs when the price rates increase extraordinarily. The price rates reach an all time high like exceeding 50% per month when an economy is grasped by the phenomenon of hyperinflation. A good instance of such an inflation occurred in 1920 in Germany when their economy shot up to an extraordinary height. Germany experienced a hyperinflation during that period.
Determinant of Theory of Inflation
The classical theory of inflation owes its genesis to certain factors. Inflation is determined by the quantity theory of money. This theory which is contained in the classical theory of inflation is employed to explain the most important and long run determinants of inflation rate and price level. Inflation is a phenomenon which takes the whole economy into its grasp. It spreads across the whole of the economy. It is such a phenomenon which impacts the whole of the economy and is concerned about the value of the mode of exchange in an economy that is, it concerns itself with money. With the rise in the supply of money the price rate rises and the value of money falls that is devaluation of money takes place.
The supply of money is controlled by the FED through a policy of open market. Open market is a powerful tool of controlling the supply of money. The demand of money actually depends on a lot of factors. These factors include interest rates, average level of prices in the economy. Every economy endeavors to reach an equilibrium where the demand and supply of the money becomes equal.
Earlier this year, Papua New Guinea moved away from a market-based exchange rate. It seemed just a technical announcement at the time. The central bank indicated that the exchange rate would float within a narrow band around the interbank exchange rate. However, this seemingly innocuous announcement has major implications for PNG’s future development. This is because the interbank exchange rate, frozen between October 2013 and 4 June 2014, no longer reflected the market equilibrium of supply and demand.
Professor at Columbia University. Recipient of the Nobel Memorial Prize in Economic Sciences in 2001 & the John Bates Clark Medal in 1979. Author of "Freefall: America, Free Markets", "The Sinking of the World Economy", "Globalisation and its Discontents" & "Making Globalisation Work".
Eric J. Gleacher Distinguished Service Professor of Finance at the Booth School of Business at the University of Chicago. IMF’s Chief Economist from September 2003 to January 2007. Inaugural recipient of the Fischer Black Prize.
Professor of Economics & Director of the Earth Institute at Columbia University. Special Adviser to the UN Secretary-General on the Millennium Development Goals. Founder & co-President of the Millennium Promise Alliance.
Vice President and Director of the Global Economy and Development Program at the Brookings Institution. Former Turkish Minister of State for Economic Affairs. Head of the United Nations Development Program (UNDP) from 2005-2009.
Andrea Edwards has worked in marketing and communications all over the globe for 20 years, and is now focused on her passion – writing. A gifted communicator, strategist, writer and avid blogger, Andrea is Managing Director of SAJE, a digital communications agency, and The Writers Shop – a regional collaboration between the best business writers in Asia Pacific
James W. Harpel Professor of Capital Formation and Growth at the John F. Kennedy School of Government in Harvard University. Director of Program in International Finance and Macroeconomics at the National Bureau of Economic Research.