Prof. (Dr.) Y. P. Sharma
The adoption of flat currency by many countries from the 18th century onwards made much larger variations in the supply of money possible. Since the huge increases in supply of paper money have taken place in a number of countries producing hyper inflation — episodes of extreme inflation rates much higher than those observed in earlier periods of commodity money. The hyper -inflation in the Weimar Republic of Germany is a notable example. Inflation occurs due to an imbalance between demand and supply of money, changes in production and distribution cost or increase in taxes on products. When economy experiences inflation i. e., when the price level of goods and services rises, the value of currency reduces. This means now each unit of currency buys fewer goods and services. Inflation is related to the value of currency itself. When currency was linked with the gold, if new gold deposits were found, the price of gold and value of currency would fall and prices of all other goods would become higher.
There are four main types of inflation.
Categorized by their speed : Creeping, Walking, Galloping and Hyperinflation. There are also many types of asset inflation and, of course, wage inflation. Many experts consider demand – pull and cost -push to be the types of inflation, but they are actually causes of inflation, as is expansion of the money supply. Creeping Inflation : Creeping or mild inflation is when prices rise 3% a year or less. According to the U.S. Federal Reserve when prices rise 2% or less, it’s actually beneficial to the economic growth. That’s because this mild inflation sets expectations that prices will continue to rise. As a result it sparks increased demand as consumers decide to buy now before prices rise in future. By increasing demand, mild inflation drives economic expansion.
Walking Inflation : This type of strong or pernicious inflation is 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, just to avoid tomorrow’s much higher prices. This drives demand even further, so that suppliers can’t keep up .More important neither can wages .As a result, common goods and services are priced out of reach of most of the people.
Galloping Inflation : When inflation rises to 10% or greater, 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, depriving it of needed capital. The economy becomes unstable and government leaders lose credibility. Galloping inflation must be prevented. Hyper- inflation : Hyper-inflation is when the prices skyrocket more than 50% a month. It is fortunately very rare. In fact, most examples of hyper-inflation have occurred when the government printed money recklessly to pay for war. Examples of hyper-inflation include Germany in 1920, Zimbabwe in the 2000s and during the American Civil War.
Causes Of Inflation Demand-pull inflation : It is when demand for goods or services increases so much that it outstrips supply. If sellers maintain the price, they will sell out. They soon realize they now have the luxury of raising prices, creating inflation. Cost-push Inflation : There are five contributors to inflation on supply side. Wage inflation increases salaries. Monopoly also controls supply of goods and services. Depletion of Natural Resources is a growing cause of Cost- push inflation. Government regulations and taxation also reduce supplies.
When a country lowers its Currency’s Exchange Rates it creates cost- push inflation in imports. Global Effects of Inflation
Effect on Redistribution of Income and Wealth:
The poor and middle classes suffer because their wages and salaries are more or less fixed but the prices of commodities continue to rise. They become more impoverished. On the other hand businessmen, industrialists, traders, real estate holders, speculators and others with variable incomes gain during rising prices. Effect on production : Price rise witnesses rise in production. Producers earn wind-fall profits in future .But further increase in investment will lead to severe inflationary pressures. Hoarding and Black Marketing : To earn more profit from rising prices, producers hoard stock of their commodities. Then they sell their products in the black market which increases inflationary pressures. Hinders Foreign Capital : The rising costs of materials and other inputs make foreign investment less profitable. Affects Govt : Govt. expenses increase with rising production costs of public projects and enterprises and increase in administrative expenses as prices and wages rise. Balance of Payments: Inflation involves sacrificing of advantages of international specialization and division of labour. It affects adversely the balance of payments of a country. When prices rise more rapidly in the home country than in foreign countries, domestic products become costlier as compared to foreign products. Exchange Rate: When prices rise more rapidly in the home country than in foreign countries, it lowers the exchange rate in relation to foreign currencies. Collapse of Monetary System: If hyper – inflation persists and the value of money continues to fall many times in a day, it ultimately leads to collapse of the monetary system, as it happened in Germany after World War – I.
Social Effect: Inflation is socially harmful. It creates discontentment among masses. Lured by profits people resort to hoarding, black marketing and speculation, etc. Political Effect: Rising prices also encourage agitations and protests by political parties opposed to the government. Many governments have been sacrificed at the altar of inflation.
Critical Challenges before Global Economy: The global financial crisis and the resulting recessions presented a massive challenge for monetary policy. As has been widely remarked, inflation targeting central banks generally did not foresee or foretell the ballooning risks of financial systems that eventually exploded. Moreover, central banks were not able to fully mitigate the spillovers to economic activity and the resulting economic costs of the crisis proved enormous. Despite inflation targeting central banks’ noteworthy successes in maintaining low inflation and anchoring inflation expectations during and after the crisis, inflation targeting faces two severe challenges. The first is the zero lower bound on nominal interest rates which has constrained conventional policy actions for most major central banks. The second is appropriate role of monetary policy maintaining financial stability.
Policies to Control Inflation:
Fiscal Policy : Controlling aggregate demand is important if inflation is to be controlled. If the Government believes that aggregate demand is too high, it may choose to tighten fiscal policy. By reducing its own spending on public goods or welfare payments. Raising direct taxes leading to a reduction in real disposable income. Monetary Policy: Tightening of monetary policy involves the central bank introducing a period of higher interest rates to reduce consumer and investment spending. Supply Side Economic Policies: Supply side policies seek to increase productivity, competition and innovation-all of which can maintain lower prices. A reduction in taxes which increases risk taking and incentives to work – a cut in income tax can be considered both a fiscal and the supply side measure. Policies to open a market to more competition to increase supply and lower the prices. Rising productivity will cause an outward shift of aggregate supply. Direct Controls: Public sector pay awards -the annual increase in government sector pay might be tightly controlled or even frozen(this means a real wage decrease). The prices of some utilities such as water bills are subject to regulatory control – if the price capping regime changes, this can have a short – term effect on the rate of inflation.
(The author is Head of the Department of Commerce Govt. Post Graduate College Rajouri, J&K )
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