Inflation

Introduction

• Inflation is defined as a long-term increase in the general price level of goods and services in a given economy. It considers the pricing of most everyday or standard products and services, such as food, clothes, housing, recreation, transportation, consumer staples, etc.
• Inflation is calculated as the average change in a basket of goods and services price over time.
• It’s calculated on a year-over-year (or monthly/weekly) basis. Point-to-point inflation is the rate of change in a specific month’s price level compared to the same month the previous year.
• Inflation is referred to as a positive when it helps improve consumer demand and consumption, and operate economic growth. Even inflation is meant to keep deflation in check and is a drag on the economy.
• The consumer price index increased to  6.7%  in 2021, which is the largest 12-month gain since June 1982,  released by Labor Department data. The widely followed inflation gauge rose 0.5% from November, exceeding forecasts.

Types of Inflation and Causes of Inflation 

Depending on the reason, inflation can be classed as Demand-Pull Inflation or Cost-Push Inflation.

Demand-Pull Inflation

• Demand-pull inflation occurs when the total demand for products and services grows faster than the economy’s production capability.
• It produces a demand-supply mismatch, with increased demand and lower supply, resulting in higher prices.
• This sort of inflation happens when the money supply expands; government spending grows, indirect taxes fall, and so on.

Cost-Push Inflation

• Cost-Push Inflation is defined as an increase in the cost of production elements such as labor, raw materials, etc.
• As the cost of production increases, inflation  rises due to which companies strive to maintain profit margins by raising prices or offering goods and services at the same price but in fewer quantities. Cost-push inflation occurs in these situations.
• Increases in the cost of manufacturing, decrease in output (production), increases in indirect taxes, increases in the price of imported commodities, and other factors contribute to this inflation.

Inflation may be classed into mild inflation, galloping inflation, hyperinflation, and so on, depending on the price increase.

Low Inflation

• Low inflation is a term that refers to a period of time where prices are slowly rising.
• Creeping inflation is another name for this sort of inflation. Crawling inflation occurs when prices rise by less than 3% each year.

Galloping Inflation

• Galloping inflation occurs when the economy’s prices of goods and services grow at a double-digit (i.e., 15%, etc.) or triple-digit (i.e., 100%, etc.) pace each year.
• Inflation that is galloping is also known as jumping inflation or running inflation.

Hyperinflation

• Hyperinflation occurs when the pace of growth in the prices of goods and services is remarkably rapid and occurs over a short period of time.
• In other terms, hyperinflation occurs when prices rise at a pace of more than three digits per year.
• After the First World War, Germany experienced hyperinflation in the 1920s. According to some accounts, Zimbabwe’s currency difficulties, the most recent incidence of hyperinflation, peaked in November 2008, with a monthly inflation rate of almost 79 billion percent.

Impact of Inflation

Positive Impact

• Stimulates Economic Growth: Inflation kept at a modest level fosters economic growth by increasing firms’ profit margins in the near run, encouraging them to boost output and supply.
• No Deficiency in Demand: It signifies that there is no demand shortage in the economy, which raises profitability expectations and encourages businesses to invest and expand production capacity.

Negative Impact

• Deteriorates Standard of Living: People’s level of life is lowered when their discretionary money is reduced.
• Deteriorates Balance of Payment Account: Inflation inhibits export and stimulates imports, widening the deficit and reducing FOREX reserves, deteriorating the Balance of Payments Account.
• Erodes Purchasing Power of Money: With an increase in the overall price level, each unit of currency can buy fewer goods and services; this implies that inflation diminishes the buying power of money– the currency loses its actual value as a medium of exchange as well as a unit of account within the economy.
• Creates Shortages of Goods: Inflationary pressures may lead to shortages of products if people begin stockpiling in anticipation of future price increases.

Conclusion

Inflation may be due to the supply of money exceeding its demand. Other factors like a decrease in production, high expenditures on consumer items, etc., can cause inflation if not matched with their demand. There are different types of inflation – Hyperinflation, creeping inflation, cost-push inflation, demand-pull inflation, stagflation, etc. It is  the steady rise of prices for goods and services over a period, and has many effects. As inflation erodes the value of cash, it encourages consumers to spend and stock up on items which are slower to lose value. It decreases the cost of borrowing and lessens unemployment.