Inflation

Introduction

• Inflation is defined as a long-term rise in the general price level of goods and services in a given economy. It takes into account the pricing of most everyday or common products and services, such as food, clothing, housing, recreation, transportation, consumer staples, and so on. 
• Inflation is the change in the average price of a basket of goods and services over time.
• It is measured on a year-on-year basis (or month/week basis). 
• The rate of change in the price level in a given month vis a vis corresponding month of last year is known as point to point inflation.

Types of Inflation

• Creeping Inflation:  When the rise in prices is very slow (i.e., less than 3% per annum), it is called creeping inflation or mild inflation. It is regarded as safe and essential for economic growth. 
• Trotting Inflation:  When prices rise moderately and the annual inflation rate is in single digit (3% – 10%), it is called walking or trotting inflation. Inflation at this rate is a warning signal for the government to control it before it turns into running inflation.
• Running Inflation: When prices rise rapidly at a rate of 10% – 20% per annum, it is called running inflation. Its control requires strong monetary and fiscal measures, otherwise it leads to hyperinflation.
• Galloping Inflation: It is when prices rise at double or triple digit rates, such as 30 % or 100 % per year. At this rate of inflation, money loses its value at a rapid rate. This level of inflation is obviously not good for the economy.
• Hyper-inflation/ Runaway Inflation: It is a very high and accelerating inflation rate. It brings a situation when the prices skyrocket more than 50 % a month. It  collapses the entire monetary system and at this inflationary stage, the government tends to use other stable currency.
• Bottleneck Inflation: It takes place when the supply falls drastically and the demand remains at the same level. It arises due to supply-side mismanagement, which is also known as structural inflation. This can be put in the demand-pull inflation category.
• Headline Inflation: It measures the change in prices of a wide range of commodities including those which have price volatility, like food and oil. In India, headline inflation is measured through the WPI. It is also known as point to point inflation.
• Core Inflation: It is also known as ‘Underlying inflation’.  It excludes temporary price volatility as in the case of some commodities such as food items, energy products, etc. It reflects the inflationary trend in the economy.

Effects of Inflation

• Salaried Persons:  Inflation reduces the purchasing power of money and it hits the salaried persons directly as their income remains consistent throughout the inflationary period. 
• Fixed Income Groups:  The recipients of transfer payments such as pensions, underemployment, insurance, social security, etc., and recipients of interest and rent live on fixed incomes.  All such persons lose because they receive fixed payments, while the value of money continues to fall with rising prices.
• Debtors and Creditors: During inflation, debtors gain and creditors lose.  When prices rise, the value of money falls. Though debtors return the same amount of money, they pay less in terms of value of money.  Thus, inflation brings about a redistribution of real wealth in favour of debtors at the cost of creditors.
• Investors:  Equity investors who hold shares of companies gain during inflation. 
• Balance of Payments: When prices rise more rapidly in the home market than in foreign markets, domestic products become costlier compared to foreign products.  This tends to increase imports and reduce exports, thereby making the balance of payment unfavourable for the country.