Inflation definition and causes

Q. What is inflation. Describe the main causes of inflation. 

Ans. Meaning of Inflation: The dictionary meaning of the word inflation is expansion or an act of inflating. In the context of prices, inflation means persistent rise in general price level.

In the words of Peterson, “The word inflation in the broadest possible sense refers to any increase in the general price level which is sustained and non-seasonal in character.”

In the words of Samuelson, “By inflation we mean a time of generally rising prices.”

In the words of Shapiro, “Inflation is simply a persistent and appreciable rise in general price level.”

In short, Inflation is the process of persistent increase in the price level. 

Causes of Inflation: Inflation is the outcome of an imbalance in demand for and supply of goods. When demand exceeds supply or cost rises then inflation takes place. Thus, causes of inflation relate to:

(1) Demand Side, and (2) Supply Side.

● (1) Demand Side: Demand refers to demand for money to buy goods. Demand for money increases mainly due to the following reasons:

(i) Increase in Public Expenditure: Increase in public expenditure in a country leads to an increase in the purchasing power which in turn leads to more demand for goods and services. But after full employment there is no increase in production of goods. As a consequence, prices begin to rise causing inflation. The situation can arise even after full employment if certain bottlenecks slow down the pace of production.

(ii) Deficit Financing: When government covers its deficit by printing more notes it leads to increase in the monetary income of the people. However, production does not increase to the extent demand for goods increases. This causes price to rise. 

(iii) Cheap Monetary Policy: Cheap money policy also causes excessive increase in supply of money and thereby increase in the demand for goods and services. It results into rise in prices.

(iv) Increase in Disposable Income: Another cause of inflation is increase in the income of consumers. Demand for goods increases due to increase in consumers’ income. When some people by consuming more goods and services make relative improvement in their standard of living, it has a demonstration effect on others. They also imitate their consumption pattern, even if their present income is low. There is thus, an increase in pressure on demand resulting into high prices.

(v) Black Money: Unaccounted money is called black money. It is the outcome of tax evasion. Holders of black money squander (waste, उड़ाना, गंवाना) it on luxuries and conspicuous (attracting attention) consumption. (Conspicuous consumption means purchasing of goods and services to display wealth, status or social power rather than to satisfy practical needs.) They do not care for prices. Consequently, demand increases and price rise. 

(vi) Increase in Investment: Increase in investment also accounts for inflation. When prospects (expectations, chances) of profits are quite bright (high), firms increases their investment. There is more capital formation. Prices of goods increase under the pressure of increased demand. Prices of other goods begin to rise in sympathy (in response to, because of a similar effect). 

(vii) Reduction in Taxes: When government reduces taxes, people’s real and monetary income increase causing increase in their effective demand. This additional purchasing power in the hands of the people stimulates (increases) their demand for goods making price-rise inevitable.

(viii) Less Public Borrowing: In case of reduced public borrowing or when old debts are repaid, people have more purchasing power exerting (applying,  creating) pressure on available goods and services resulting in inflation.

(ix) Increase in Population: If the growth rate of population is higher than the growth rate of output in the country, demand for goods and services outstrips (exceeds, is more than) their supply causing rise in prices. 

(x) Increase in Exports: Rising exports push up prices on two counts: (a) More exports mean more income and hence more demand for goods and services by the exporters leading to rise in the prices. (b) More exports of consumer goods mean less supply for domestic consumption and so rise in their prices. 

● (2) Supply Side: Supply refers to the quantity of available goods or output on which people spend their income. In case of inflation supply of goods and services does not increase proportionate in the demand. As a result, there is disequilibrium in the economy. It is this disequilibrium that causes rise in prices. Following factors may be noted in this regard.

(i) Less Production: Fall in production is one of the principal causes of rise in prices. Fall in agricultural or industrial production in relation to demand leads to rise in prices. Production may fall due to diverse reasons such as, disputes between employers and employees, natural calamities, under-utilisation of production capacity or non availability of the strategic (important/crucial) inputs. 

(ii) Artificial Scarcity: Hoarders and Profiteers create artificial scarcity of goods by way of hoarding.

(iii) Taxation Policy of the Government: High rates of sales tax, excise duty, corporation tax, expenditure tax, etc., discourage production. Under the situation even when demand for goods remain constant there will be rise in their prices. Thus, fall in production give rise to inflation.

(iv) Shortage of food grains: In the event of short fall of the production of foodgrains, pulses, edible oils, etc., their prices shoot up. This shortage may be due to failure of monsoon or more production of cash crops than food crops.

(v) Industrial Disputes: Sometimes industrial disputes may culminate (result) into strike or lockout. It causes fall in supply or production and hence rise in prices.

(vi) Technical Changes: New inventions ever take place in this dynamic age of science. Switching over to new techniques takes time, with the result production process is slowed down. However, technicians and specialists are paid their remuneration as usual. This increases cost of production only to accelerate the inflationary pressure.

(vii) Lack of Raw Materials: Lack of raw materials within the country and little hope of its availability from abroad reduces production and pushes up prices.

(viii) Natural calamities: Agricultural production is occasionally (कभी-कभार) exposed (open, not protected) to such natural calamities as floods and droughts, prices of the agricultural products therefore rise.

(ix) Productive Set up: Sometimes production pattern in the country undergoes such a change that producers begin to produce more and more luxury goods or basic and heavy goods. It is so because production of these goods is more profitable that mass consumer goods. Consequently, income of the labourers increases and so also their demand for wage goods. This causes the prices of such goods to rise very much.

(x) War: Production of consumer goods falls heavily during war time, because productive resources are diverted to the production of war-goods. It raises the prices of production goods.

(xi) International Causes: In modern times different countries have trade relations with one another. Price rise in one of the trading countries has its effect on other countries as well. Inflation in one country spreads through other countries through trade. For example, one of the reasons for global inflation in modern times is the price-hike of petrol and petroleum products.

(xii) Industrial Policy of Government: If industrial policy of the government is restrictive, it would adversely affect supply. If the setting up of a new industry is strictly controlled, then production would fail to cope with demand and so prices will rise.

(xiii) Bottlenecks in Production: When the supply of electricity, coal, means of transport, etc., becomes erratic, production slows down. As a consequence, supply falls and prices rise.