When prices of any commodity raise the purchasing power of money reduces. In common man parlance, it is known as dearness, whereas from the angle of an economist it has many connotations. Inflation is precisely nothing more than a price rise over a period of time. No one is untouched with this common feature of any economy. Whereas the rise in price is the ultimate effect on the consumer, there may be several reasons behind this. In this article, we will discuss the various types of inflation, its cause of happening and the most practised steps to tackle it.
Table Of Content:
- What is Inflation?
- Why Inflation Occurs?
- Types of Inflation
- Other Variant Of Inflation
What is Inflation?
Inflation is described as an increase in the general level of prices in an economy that is sustained over a period of time. Mainly there are four types of inflation creeping inflation, walking inflation, galloping inflation and hyperinflation. We calculate the rate of inflation by using this formula:
Rate of inflation (year x) = Price level (year x) – Price level (year x-1) / Price level (year x-1) * 100
Why Inflation Occurs?
Economists have been giving different explanations about the occurrence of inflation and still, it is a debatable topic. Here we will learn about the most acceptable reasons for the occurrence of inflation.
When too much money chasing very little output then it creates the demand-pull inflation. In other words, demand-pull inflation occurs when the purchasing power of consumer increases over the same level of goods. Let us understand with an example, suppose there are 3 people who get into a shop to buy a packet of salt, the shopkeeper looks at his storeroom and find that there is only 3 packet of salt left in the store but he gives salt’s packet to each consumer. Now let us focus on the second condition, what happen if the number of consumer increases from 3 to 6 who demands a packet of salt. Can the shopkeeper fulfil the demand of all 6 people? No, he cannot fulfil the demand of all the people due to the limited quantity of salt’s packet. Now in this condition what he will do? He will demand extra money from consumers for the same salt. Now who will agree to pay this extra money to the shopkeeper, he will give salt’s packet to him. Means high demand can increase the price level of goods if the goods are in limited quantity.
Cost-Push inflation is a condition when the purchasing power of consumer decreases. In this condition, goods are sufficient in the market but consumers have no money to purchase those goods. To fight with Cost-Push Inflation government have to create substitute of that particular goods. Let us understand with an example, suppose a consumer has Rs 1000 and he wants to purchase a mobile phone. He goes to market but he found that there is no mobile phone which suits his pocket. Here he has money but due to the higher cost of mobile, he cannot purchase that mobile phone. This scenario is known as Cost-Push Inflation. There are so many reasons behind Cost-Push Inflation some are direct and some are indirect. Let us understand, suppose the government ban Chinese goods. We all know that Chinese goods are cheaper than Indian goods. If a consumer wants to purchase any item he can choose according to their pocket size because goods are available in all price range. But when the government bans Chinese goods people are left with only one option to purchase those goods at a higher price because the cheaper option has now vanished from the market. Here you can see that if the government bans any particular item then it directly triggered the Cost-Push Inflation. Now think about what happens if the prices of fossil fuels increase drastically. As we all aware of this point that the transportation costs are also added to the final cost of goods. Now if the prices of fossil fuels increase drastically then the transportation cost will also increase and due to higher transportation cost, the final cost of goods will also increase. Here you can clearly see how the Cost-Push Inflation is indirectly triggered.
Types Of Inflation
Creeping inflation shows that the prices of goods and services are rising at a rate of 3% a year or less. It is an inflation that is on the predictable lines. According to the Central Bank, when prices increase 2% or less, it benefits economic growth. This kind of mild inflation makes consumers expect that prices will keep going up. That boosts demand. Consumers buy now to beat higher future prices. That’s how creeping inflation drives economic expansion. For that reason, the Central Bank sets (2-3)% as its target inflation rate.
This can be described as a strong or destructive situation. In this situation, inflation rises between 3-10% a year. It is harmful to the economy because it heats-up economic growth too fast. People start to buy more than they need to avoid tomorrow’s much higher prices. This increased buying drives demand even further so that suppliers cannot keep up. More important, neither can wages. As a result of this extra buying, common goods and services are priced out of the reach of most people.
When inflation rises to 10% or more, it wreaks absolute havoc on the economy. Money loses value so fast that business and employee income can’t keep up with costs and prices. Foreign investors avoid the country becomes unstable, and government leaders lose credibility. Galloping inflation must be prevented at all costs.
Hyperinflation is when the prices of goods and services increase drastically or more than 50% a month. It happens very rarely. In fact, in most examples of hyperinflation economist noticed that the hyperinflation occur when governments print more and more money to pay for wars. Examples of hyperinflation include Germany in the 1920s, Zimbabwe in the 2000s, and Venezuela in the 2010s. The last time America experienced hyperinflation was during its civil war.
OTHER VARIANTS OF INFLATION
Bottleneck Inflation takes when the demand remains at the same level but the supply of goods falls drastically. This type of situation arises due to structural problems like supply-side accidents or mismanagement. That is why it is also known as ‘structural inflation‘.
The core inflation rate measures rising prices in all the goods and services except food and energy. That’s because fuel prices tend to escalate every summer. Families use more fuel to go on vacation. Higher gas costs increase the price of food and anything else because of the high transportation costs. The Central Bank uses the core inflation rate to guide it in setting monetary policy.
Reflation is a situation when the government implement some policy to revive the economy from high unemployment, low inflation, low demand etc. To revive the economy from these problems the government have to infuse money in the market or increase employment or give tax rebate or increase wages and this all things increase the purchasing power of the consumer. This scenario also increases the price of certain goods and such price rise known as reflation.
A situation when inflation and unemployment both are at higher levels is know as stagflation. This situation looks like an impossible situation. You can also think on it that when economy is facing high unemployment then how inflation occurs? But in 1970s the US economy faced this situation. If an economy is going through the cycle of stagflation then the government have to implement some economic policies to increase employment and reduce inflation.