THE OGRE OF INFLATION

CAUSES, SOLUTIONS AND

SIDE EFFECTS

SUBMITTED TO,
SIJI CYRIAC

SUBMITTED BY,
TEAM SCORPIO
⇒INFLATION:

Inflation is a process in which the price is rising at a rapid rate and

the money is losing its value. In the words of Gardner Ackley, “Inflation
may be defined as a persistent and appreciable rise in general level of
average of prices.” It may here denote that rising general level of price
doesn’t mean that all prices are necessarily rising. Even during inflation,
the prices of some goods may remain relatively constant and a few
others actually falling. Inflation also does not mean that prices of goods
rise evenly or proportionately. Inflation is an upward movement in the
general (average) level of prices. In Pakistan, the general price level is
persistently rising since Partition of the Subcontinent. Prices remained
volatile during the decade of 1990’s ranging form 5.7% to 13% mainly
because of declining economic growth, expansionary policies, output set
backs, higher taxes and a depreciation of Pakistani rupee. The inflation
rate started declining form 1998 on ward due to improved supply
position of goods, strict budgetary measures. The inflation rate was
5.7% in 1998-99. It was brought down to 3.6% in 1992-2000 and further
to 3.1% in 2002-03. The inflation rate based on the CPI (Consumer
Price Index) has averaged 4.6% during 2003-04. The slight rise in prices
was the year 2004-05 mainly due to rise in the price of wheat and an
increase in the international oil price.
⇒CAUSES OF INFLATION:

The causes of inflation are generally grouped under two main heads
(a) Demand Pull Inflation (b) Cost Push Inflation.
A. Demand Pull Inflation:
Demand pull inflation occurs when aggregate demand for goods
exceeds aggregate supply of goods at current prices, thus leading to an
increase in the price level. The factors of which bring about increase in
aggregate demand for goods or rise in the general level of prices are
grouped under two separate heads; (i) Factors operating on demand side
(ii) Factors operating on the supply side.
(a) Factors operating on the demand side : These are the factors
which bring continuous rise in the general price level.
(1) Increase in money supply: An increase in money supply leads to an
increase in money income. The increase in money income raises the
aggregate demand for goods and services in the country. The supply of
money increases when the govt. resorts to deficit financing or the
commercial banks expand credit. When too much money chases too few
goods, the result is an increase in general price level.
(2) Increase in Government expenditure : If there is increase in govt.
expenditure due to adoption of development and welfare activities of the
country has to flight a war, it causes as increase in govt. expenditure
which leads to increase in aggregate demand for goods and services and
hence the price level goes up.
(3) Increase in private expenditure: A continuous increase in
consumption and investment expenditure in the private sector raises the
demand for goods and services and leads to inflationary rise in prices.
(4) Increase in population: The rapid rising population exerts pressure
on the demand for goods and services. If the supply of goods and
services fail to match with the demand, the general price level moves
upward.
(5) Black money: The money generated through smuggling, tax evasion
etc. raises the demand for luxury and other goods. Hence black money is
also one of the causes in raising the aggregate demand for goods and a
rise in general price level.
(b) Factors causing decrease in supply of goods: If the increase in
aggregate demand for goods and services is matched by an increase in
the supply of goods, it will not cause inflationary situation. When the
aggregate supply of goods is at a slower pace than the growth in
aggregate demand, it then causes inflationary rise in prices.

The following factors are identified for relatively slower growth in the
supply of goods.
(i) Lagging agricultural & industrial production: The increase in
population, incomes, employment and urbanization exert pressure on the
demand for goods and services. However, the agricultural and industrial
production grows at a slower pace, due to shortage of essential inputs
like fertilizers, water, cement, iron etc. When aggregate demand for
goods and services exceeds the aggregate supply of it, it causes a rise in
the prices of agricultural and industrial goods.
(ii) Inadequate infrastructure facilities: If, in a country there is
shortage of power,transport and communication facilities are slow and
inefficient, it results in the slowing down of overall production of goods.
When the supply of goods falls short of demand, the prices go up in the
country.
(iii) Long gestation period: If the time lag between investment and the
production of goods is long, the shortage of goods will arise. This will
also contribute to inflationary pressure in the economy.
B. Cost Push Inflation:
Cost push inflation occurs when there is an increase in the cost of
production of goods and is not associated with excess demand. The main
causes of cost push inflation are:
(1) Increase in money wage rate: The wage push inflation occurs when
strong labour unions manage to press for wage increases in excess of
labour productivity. Unit cost of production is thereby raised. The rise in
cost of production exerts pressure on sellers to increase prices of goods
so as to get profit margin.
(2) Profit push inflation: If the producers of certain commodities have
monopoly or near monopoly power in the market, they fix up higher
profit margins arbitrarily without any increase in other elements of cost.
When a few powerful firms increase the profit margins, the smaller
firms also tend to mark up their profit margins. The higher profit
margins, thus, inflate the price level.
(3) Material push inflation: If there is increase in the prices of some
basic materials such as gas, steel, chemicals, oil etc which are used
directly or indirectly in almost all industries, it causes an increase in the
cost of production and hence in the general price level.
(4) Higher taxes: If the government levies new taxes and raises the
rates of old taxes the producers generally shift the burden of taxes on to
the consumers. The increases in the selling prices of the commodities
push up the inflationary trend in the economy.
(5) Import prices: If prices of imported goods increase, it also results in
the contribution of inflation.
⇒KINDS OF INFLATION:
Inflation is of different types. It is generally classified on the following
basis.
•On the Basis of Rate of Inflation:
(i) Creeping Inflation: It is a situation in which the rise in general price
level is at a very slow rate over a period of time. Under creeping
inflation, the price level raises upto a rate of 2% per annum. A mild
inflation is generally considered a necessary condition of economic
growth.
(ii) Walking Inflation: Walking inflation is a marked increase in the
rate of inflation as compared to creeping inflation. The price rise is
around 5% annually.
(iii) Running Inflation: Under running inflation, the price increases is
about 8% to 10% per annum.
(iv) Galloping or Hyper Inflation: Galloping inflation is a full
inflation. Keynes calls it as the final stage of inflation. It is a stage of
inflation which starts after the level of full employment is reached. Here
price level rises very rapidly within a short period.
•On the Basis of Degree of Control:
(i) Open Inflation: It is a stage when the rise in price level gets out of
control. Milton Friedman describes it as “inflationary process in which
prices are permitted to rise without being suppressed by government
price control or similar measures.
(ii) Suppressed Inflation: Under this type of inflation, the government
makes efforts to check and control the rise in price level through price
and rationing. When price level is suppressed by the above short term
measures, it results in many evils such black marketing, hoarding,
corruption & profiteering.
•Inflation on the Basis of Causes:
(i) Demand Pull Inflation: Inflation caused by increase in aggregate
demand, not matched by aggregate supply of goods, resulting in rise of
general price level is called demand pull inflation. Demand pull inflation
to be simpler, occurs when the demand for goods and services in the
country is more than their supply. The effective demand for goods
increases due to many factors such as increase in money supply,
increase in the demand for goods by the government, increase in the
income of various factors of production etc. In short, the excessive
increase in the money supply causes inflationary conditions. Demand
pull inflation is generally characterized by shortage of goods and
shortage of workers.

(ii) Cost Push Inflation: Cost push inflation occurs when the increasing
cost of production pushes up the general price level. Cost pull inflation
occurs when the economy is below full employment with prices rising
even though there is no shortage of goods. Cost push inflation is the
result of increase in wage costs unaccompanied by corresponding
increase in productivity, rise in import prices of goods, depreciation in
the external value of the currency, higher mark up etc, etc.
(iii) Profit Induced Inflation: Profit inflation is in fact categorized
under cost push inflation. When entrepreneur, due to their monopoly
position raise the profit margin on goods. It may cause profit push
inflation.
(iv) Budgetary Inflation: When the government of a country occurs the
deficits in the budgets through bank borrowing and creating new money
(Deficit Financing), the purchasing power of commodity increases
without a simultaneous increase in the production of goods. This leads
to rise in the general price level.
(v) Monetary Inflation: Milton Friedman is of the firm view that
inflation is always and anywhere a monetary phenomenon. According to
him, inflation is caused by a too rapid increase in the money supply and
by nothing else.
(vi) Multi Casual Inflation: Inflation has a number of causes. It may be
caused by increase in money supply, excessive wage demands, excess
aggregate demand for goods, shortage of goods etc. The chief cause of
inflation in one year may not be in the next year. Since inflation is multi
causal, therefore a variety of policy measures are needed to deal with it.
•On the Basis of Employment:
(i) Partial Inflation: According to J.M. Keynes, takes place when the
general price level rises partly due to an increase in the cost of
production of goods and partly due to rise in supply of money before the
full employment stage is reached.
(ii) Full Inflation: Full inflation prevails when the economy has reached
the level of full employment. Any increase in money supply beyond full
employment. It is also called as real inflation.
•Anticipated versus Unanticipated Inflation:
(i) Anticipated inflation is the rate of inflation which majority of the
individual believes will occur. When the rate of inflation (say 6%) turns
out to be same (6%) we are then in a situation of fully anticipated
inflation.
(ii) Unanticipated inflation is that which comes as a surprise to majority
of individuals. It can be higher or lower than the rate of anticipated
inflation.
SIDE EFFECTS OF INFLATION
I have this strong hunch that the galloping inflation is indirectly going to
regulate the life of middle class for the better. My logic is as follows.
Increase of petrol price; the increase in petrol price is going to force
people to use less of personal conveyance and depend more on public
transport and thus walk upto the bus stands or the metro. This will
improve the health of the individual. The youth will have less of pocket
money and also have to pay more for the petrol of their two wheelers, so
less of zipping around and leading more disciplined life.
Increase of prices of vegetables, fish meat etc; no more bulk purchase
of vegetables. So walk every day to the daily market for fresh vegetable
and walk longer for cheaper stuff. The increase of cost of mutton means
eating less of red meat and thus reducing the chances of heart attack.
Costlier restaurant food; so less of eating out and thus more of home
cooked food. Even the eating of junk food will come down as
dispensable money in the pocket of the school and college going kids
will be less.
Costlier edible oil; those deep fried foods will go out slowly. People
will adopt more of pan fried kind of food with less oil. Indians are often
accused of going fat because of eating more of fried foods. So the
chances of putting on weight will decrease, we will have healthier
population.
Cost of electricity going up; People will try to use less of air
conditioning in the homes. This again will indirectly help them to
become healthy in natural environment and also less load on the
electricity grids.
Increase of plane fare; this will really help those neglected nana nanis,
now papas and mamas can not make those Goa trips during holidays,
instead they will take them to their villages to visit nana , nanis like old
time and thus those poor souls will get the much needed attention in the
twilight of their lives.
Less of pocket money to the kids; this will hit those malls and
multiplexes. The number of pop corn chewing youth going for those
multiplexes will reduce as they will opt for those good old cinema halls
which show movies at less than half the price.
Well folks on the whole this inflation is going to have more
multidimensional effects as all of us in our own way are going to prune
our household budget to match the income, but the effect on quality of
life may improve as time spent in door is going to increase.
⇒REMEDIES OF INFLATION

The first panacea for a mismanagement nation is inflation of the

currency. The second is war. Both bring a permanent ruin. They both are
the refuge of political and economic opportunities. (Ernest Hemingway).
To avoid political unrest and harmful, social and economic effects on
the economy, it is the main objective of every government to take
appropriate measures to control inflation. The main measures which are
used to control inflation are (1) MONETARY POLICY (2) FISCAL
POLICY and other measures:
1. Monetary Policy
Monetary policy is a policy that influences the economy through
changes in the money supply and available credit. Monetary policy is
adopted by central bank of a country. The various monetary measures
which are used to control inflation are grouped under two heads (a)
Quantitative controls (b) Qualitative controls. They are (1) Open market
operations (2) Variation in bank rates (3) Credit rationing (4) Varying
reserve requirements (5) Varying margin requirements (6) Consumer
credit regulations.
2. Fiscal Policy
Fiscal policy is the deliberate change in either government spending or
taxes to stimulate or slow down the economy. It is the budgetary policy
of the government relating to taxes public expenditure, public borrowing
and deficit financing. Fiscal policy is based upon demand management
i.e, raising or lowering the level of aggregate demand by controlling
various expenditures, government expenditure, consumption
expenditure and investment expenditure. The main fiscal measures are:
oChanges in taxation If the Govt: of a country brings about changes in
tax rates, it can help stabilization of prices in the country. For example.
A decrease in taxes relates increases disposable income in relation to
national income hence, consumption rises at every level of national
income. With the increase in aggregate demand for goods, the
employment goes up in the country. A rise in tax rates has the opposite
effect. A rise in taxes causes a decrease in disposable income, creates a
larger budget deficit and brings relief from inflation.
oChanges in Govt. Expenditure
If inflation is at or above the level of full employment in the country, the
government can bring down price level by curtailing its own
unproductive expenditure.
oPublic borrowing
Public borrowing is another effective method of controlling inflation.
Public borrowing reduces the aggregate demand for goods and hence
price level
oBalanced budget Changes
A balanced budget decrease has a mild contractionary effect on national
income and hence on bringing down the price level.
oControl of deficit financing
For financing the budget deficit, the govt. often resorts to deficit
financing . the bank borrowing and printing of new notes increases the
money supply in the country and pushes up the price level. Deficit
financing therefore, should be avoided to control inflation.
Others Measures:
Apart from fiscal and monetary measures, the other measures which are
helpful in controlling inflation are;
(a)Price support programme.
(b)Provision subsidies.
(c)Arrangements of easy availability of goods on hire purchase to
stimulatedemand.
(d) Imposing direct control on prices of essential items.
(e)Rationing of essential consumer goods in case of acute emergency
holding ofFriday and Sunday markets.

Since 1950’s the control of inflation has become the chief objective of
both developing and developed countries of the world. The government
therefore take monetary, fiscal and other measures to combat inflation.