Brief Note on the Causes of Inflation

Inflation is an important concept that deals with the increase in the prices of an economy over a period of a specified time. Every time the prices increase in an economy, every currency unit buys comparatively lesser goods and services. Also, hyperinflation directly affects the purchasing power of consumers. The Reserve Bank of India RBI released the Currency and Finance report on February 26, 2021. 

According to reports, there is a significant rise of 6.30% in the annual retail inflation rate every year in May, followed by 4.29% in April. In all, the price inflation has risen to 12.94%, which is the maximum in the last two decades. 

Causes of Inflation 

Inflation is described as the rise in the prices of goods over a specific period of time. When the condition of inflation occurs in an economy, it minimises your power to buy goods and services. 

Demand-pull inflation 

When the aggregate demand in the economy increases and becomes greater than the ability of the economy to fulfil these demands, it leads to demand-pull inflation. There are several causes of this type of inflation. These include: 

• Increase in the money supply in the economy 
• Rise in the Forex reserves. 
• Due to fiscal stimulus.
• Government spendings
• Depreciation of rupee.
• Increased borrowing.
• Low unemployment rate.

Cost-push inflation 

Because of the rising wages and materials, there is an increase in the prices of the end goods. These costs are often paid by the consumers. There are several reasons why the condition of cost-push inflation occurs in an economy. Here is a list of causes of cost-push inflation: 

• Speculation and hoarding of commodities.
• Fluctuation in the prices of crude oil. 
• Low growth in the Agricultural sector.
• Defects in the food supply chain.
• Rise in the Interest rates by RBI.
• Increase in the prices of inputs.
• Defects in the Supply chain.
• Currency depreciation .
• The rise in indirect taxes.
• Food Inflation.

Devaluation: Devaluation is the downward adjustment in the exchange rate of an organisation or state. It leads to a lower value for the country’s currency. In case the currency gets devalued, the rate of export of the country minimises, encouraging countries to go for more devalued goods. 

Increased Money Supply: The increased money supply refers to the total money, including notes, coins, and bank accounts in circulation in an economy. In case the rate of the increase in money supply is more than that of the production rate, it gives rise to inflation. Through the process of Open Market Operations or OMO, the money supply increases in an economy. 

Built-in inflation 

In this type of inflation, a high wage demand is aroused by the workers. Such demands are fulfilled by raising the prices of the end product. 

Increased wages: Wages are the salary paid to workers. These are paid on an hourly basis. If there are rising wages, businesses have to increase the prices of the final commodity or live with low margins. Hence, the condition of inflation occurs in the economy. 

When inflation occurs, its effects can be seen from a distance. Here are some of the effects of inflation. 

• Effects on production: In case the prices of goods and services increase, it also motivates producers to produce more. Hence, they utilise all resources to produce more. However, after reaching the stage of complete employment, production stops at a certain point as all resources are fully utilised.
• Effects of employment and income: As production and spending increase, the national income also increases. Also, it gives rise to employment opportunities as there is a higher need for workers. However, the income of the people falls because of the massive fall in the purchasing power of the money.
• Effects of government finance: During high inflation, the government revenue increases as they get revenue in different forms, including tax, sales tax, excise duties, and so on. However, the government is expected to spend more. As a result, public expenditure boosts. But the rise in prices reduces the burden of public debt. 
• Effects on growth: It is believed that mild inflation contributes to economic growth; hyperinflation can negatively affect the growth of an economy. 

Conclusion 

Inflation is a crucial topic that majorly deals with the increase in the prices of an economy over a period of a specified time. It is believed that in developing countries like India, mild inflation is the ideal condition. Every time the prices in an economy increase, every currency unit buys comparatively lesser goods and services. There are several causes of inflation, such as devaluation and depreciation of the currency, among many others.

The  effects of inflation are seen in the distribution of income and wealth, production, income and employment, business and trade, government finance, and, lastly, the economy’s overall growth. The government has formulated policies and regulations to control the condition.