Economics of Inflation encompasses all the necessary information regarding the phenomenon of inflation. When the price of goods in an economy rises above the normal level the economy is said to be facing an inflationary situation. In the classical economics theory it was believed that inflation occurred only due to the increase in the supply of money. But later on with other developments, and increasing pressure many reasons were found out due to which inflation takes place. In the present times the definition of inflation has changed slightly. Now it is said that inflation is a situation where money supply increases without the required increase in the supply of goods and services. Therefore two factors turn out to be the major ones while studying the economics of inflation.
Measurement of inflation
Inflation is measured against the purchasing power index. But there is no universal price index to measure inflation because in different economies the price varies differently. Therefore, different price indexes exist against which inflation is measured. The two indexes which are most commonly used while measuring inflation are:
- GDP Deflator
- Consumer Price Index
Consumer Price Index measures nominal consumer prices and GDP deflator measures the nominal value of goods and services that are produced by the different countries region respectively.
Causes of Inflation
The research on the causes of inflation has been done by two schools. The first school of economists is known as the 'monetarists' who stress on the influence of money on the rate of inflation and the other school is known as 'Keynesians' who emphasize on the monetary effect along with the interest rates and output influencing inflation level. There is another school known as the Austrian School of Economics who believe that the supply of money controls the rate of inflation.
The different schools of economists could never find a universal solution to the problem of finding out the causes for inflation but they are can be divided into two broad categories:
- Quantity Theories of Inflation
- Quality Theories of Inflation
David Hume and Adam Smith dually introduced two theories: Quality theory of inflation for production and a Quantity theory of inflation for money. There is an existence of a Triangle Model in economics which defines the causes behind inflation. This was introduced by Robert J Gordon. The triangle consists of three factors. They are:
- Demand-Pull Inflation- in this the inflation is caused due to the increase in demand.
- Cost-Push- this inflation is caused due to the increase in supply and the decrease n production.
- Built-In Inflation-this inflation is caused due to the conflict between the workers who demand higher wage and the owners who pass on this burden to the consumers to compensate their expenditure.