Impacts of Inflation

 

Inflation is a situation when worth of money decreases. It is caused by excess of money supply in a particular economy. Whenever, money supply exceeds the demand for money, inflation results. In simple terms, inflation corresponds to reduced purchasing power. According to Milton Friedman, inflation is essentially a monetary phenomenon. However, this is particularly true for long run inflation. The short term inflation and medium term inflation, on the other hand, depend on a variety of other factors like relative elasticities of price levels, wages and rates of interest.

There are different schools of economics that come with different reasons of inflation. They can be broadly categorized into quantity theories of inflation and quality theories of inflation. The quantity theory of inflation is based on the money supply equation, whereas, quality theory of inflation has been developed on the idea of buyers’ expectations of exchanging currency with desired commodity at a future date.

Categorization of Inflation

According to Keynesian economics there are two basic two basic types of inflation, Demand-Pull Inflation and Cost-Push Inflation.

The concept of Demand-Pull Inflation deals with the idea that demand for goods and services in an economy is more than the supply. This excess demand pushes up the price until equilibrium is attained at a higher price level. So, inflation here is demand-driven. Now, the point that needs to be clarified here is what causes the aggregate demand to go up. Increase in government expenditures, increase in supply of money and increase in the price level in other parts of the world are three primary factors that cause the aggregate demand to go up.

Cost-Push Inflation results from a decline in aggregate supply. Rise in prices of raw materials and wage rates are two major factors behind Cost-Push Inflation. However, it may result from increase in prices of any of the factors like land, labor, capital and organization that are involved in production. When there is an increase in cost of production or operation, the profit margin of the entrepreneurs decreases. The increased operational costs are transferred to the customers in the form of higher prices. This results in Cost-Push Inflation.

According to the monetarist economists, money supply is the key factor behind inflation. If the central banks fail to control money supply properly, the rate of growth of money supply may exceed the growth rate of potential output that is the real GDP. This causes the price level to go up, resulting in inflation.

Impacts of Inflation

A small increase in price level is considered to be beneficial for the economy. Inflation generally increases the price level gradually over time. When price starts increasing, the consumers may opt for making purchases at present time, out of the fear of further increase in price level in future. This tendency of the buyers increases the spending and borrowing activities in the short term period. It provides additional mobility to the economic performance of the economy.

Inflation can have severe impact on the retired people who live on a fixed source of income. As price level keeps on increasing, the worth of their savings decreases and they find it really difficult to maintain their livelihood.

If the imbalance between demand and supply and the resulting inflation go beyond the control of the government, both the producers and buyers get adversely affected. The buyers cut down their day-to-day expenditures to cope with the increasing price level. The producers on the other hand, reduces their output levels to retain the minimum profit margin.

Inflation, the Challenge before Global Economy

Considering the failure of US sub prime market and the subsequent recession in US economy, controlling the increasing rate of inflation is the greatest challenge that the world is confronting for some time now.

The Indian and Chinese governments are taking care of the inflationary situations very seriously. In Europe, interest rates have been maintained at higher side to keep inflation under control.

Fiscal policy measures like reducing government expenditure and increasing rate of taxation can also be used to check inflation. Attempts are on to bring about regulatory changes to face the challenge of inflation.