Inflation: A Critical Study

By Anonymous

Introduction

Nowadays, on almost every news channel and in almost every newspaper, we hear that this will happen if inflation eases, monetary policy may ease if inflation comes down, inflation increases by this much percentage, inflation rises to this level in this month and what all and what not. Now, at the same time as the inflation is so much into news all over, there are many people like me who do not get what all these news channels and newspapers are talking about.

Inflation, which is one of the most heated topics of debate in almost every sphere of world today has to be explained in a way, which makes almost every citizen of his/her own country understand such an important issue from its root level and actively participate in such debates. This participation can be in the form of a speaker in a forum, discussion in a college/university or even from a viewer’s point of view.

In this paper, I would be doing an in depth study on the topic of Inflation from various sources, as the name suggests and analyze this study from a common man’s point of view. I would be covering various aspects of Inflation including types of inflation, effects of inflation and other important terminologies attached to the broader topic of Inflation.

This paper will try to give a background of what inflation is all about and why should we be so worried about it, or in other words, why is there a need to understand this topic. I would be using the studies of various researchers, economists, lecturers and active writers on economic issues.

Inflation

An economist’s definition of Inflations says that “Inflation means a sustained increase in the aggregate or general price level in an economy which results in an increase in the cost of living.”[i]

According to Keynes, “Inflation is the result of the excess of aggregate demand over the available aggregate supply and true inflation starts only after full employment”.

(John Maynard Keynes, 5 June 1883 to 21 April 1946, was a British economist whose ideas affected the theory and practice of modern macroeconomics and informed the economic policies of governments.)[ii]

According to Prof. Crowther, “Inflation is a state in which the value of money is falling and prices are rising.”[iii]

Loosely speaking, inflation means that your money will not be able to buy an amount of various items today, as you could have bought yesterday with the same money, or, just that you need more money for that quantity of items.

A simple example of inflation can be that if 1 kg. Of tomatoes cost ₹100 in the year 2008-09 and the inflation increases in the following year, the amount of same quantity of tomatoes will also increase above 100 depending upon the increase in the percentage of inflation.

Inflation has been studied and written upon by many renowned names in the branch of Economics like A.J. Hagger, John Stanton Flemming, Thomas Wilson and many more. Another such name is John Hudson, who, in his book titled ‘Inflation: a theoretical survey and syntheses’ has examined his theory on inflation and tried to verify it by applying it to the more practical approaches of UK and USA.

Now there are various features of inflation which come from various theories of inflation and these features are namely;

  • It is always followed by a rise in price level.
  • A cyclical movement of prices is not inflation
  • It may be demand pull or cost push.
  • Pure inflation starts after full employment.
  • It is a monetary phenomenon and generally caused by excessive money supply.
  • It’s a dynamic process as observed over a long period of time.
  • Excessive demand in relation to the supply of everything forms the essence of inflation.[iv]

Causes and Effects of Inflation

Increase in demand and decrease in supply has been one of the most favorite answers of people to whom this question is asked of explaining the causes of Inflation. And no doubt, this is one of the main reasons of increasing inflation anywhere you see. But there are certain other theories attached to it when it comes to explaining the causes of Inflation.

Following come out to be the real causes of inflation as per the study done by someone called Naveen Kalyani for the ‘theglobalecon.com.’

  1. Population on  the  rise;
  2. High economic  growth;
  3. Lack of  agricultural  output;
  4. Weak INR; &
  5. Cost of output heading to north.[v]

Now there are some minor causes too which ultimately link to the major ones mentioned above which can be said to be more of the layman’s reasons of Inflation;

  1. Weak Infrastructure and transportation,
  2. Climatic conditions,

1. Lack of supply of factors of production, etc., Population on the rise

Nothing new, but the population has and has been continuously increasing in the north direction for India. Talking in numbers;

  • India’s population in 2001 was around 1.01 billion, and
  • India’s population in 2010 was around 1.21 billion.

When the increase in population goes hand in hand with the supply of essential commodities in the market, of course at palatable prices, then it is called as growth. But when the supply of commodities takes up the slower pace in comparison to the population, then that is the time to be worried about and India being the biggest example of it. When this problem starts getting on the nerves of producers and they are unable to meet the demand requirement, then increasing prices of all concerned economic goods and services is the only option left in their hands. Thus, increasing population results in economic inflation.

2. High economic growth

A British economist, David Henderson, believes that economic growth would lead to inflation.

India is the 10th. largest economy of the world after Japan, Germany, Brazil, China and the USA, etc. according to data of June, 2012. The economic growth of India has been increasing every financial year, projecting more than 6& a year. This is something what each and every productive person also wishes for. But imbalances in the contributions made by the economic sectors in the economy also give a feasible room for inflation, even if there is a balance in the contributions made by each sector i.e. 33.3% by each sector.

For example:

Assume a 10% growth in the Indian economy in the financial year 2011, with the following contributions made by different sectors.

Primary Sector – 33%

Secondary Sector – 30%

Tertiary Sector – 37%

This situation may seem perfect, but for the matter of fact there is still some scope of inflation as the Indian economy depends upon foreign trade i.e. goods and services resulting in a fall in INR which leads to rise in the value of foreign goods and services and hence, making them inflated goods.[vi]

3. Lack of agricultural  output

Agricultural sector has been one of the sectors which have worried Indian economy the most and there are several reasons for it. One being that this sector failed to meet the domestic demand expectations and other that it failed to generate anticipated GDP contributions. It has been recommended several times by many economists, advisers on economy, etc. to invest in this particular sector, but even after that, the result has not been very different.

This, as always leaves the producers with only one option of increasing the prices of the commodities and this finally resulting in economic inflation. Talking particularly about the issue of agriculture, there are certain scientific reasons for such a problem:

  1. Climate change.
  2. Usage of old tech and methods are on or underway.
  3. Lack of reliance on new tech.
  4. Lack economic planning and executions made by farmers and other concerned in the agriculture field, too.
  5. Lack of finance, etc.

This should be looked upon very seriously as food inflation forms an integral part of the inflation in general.

4. Weak INR

Weak INR is one of the key factors affecting inflation in an economy. When INR falls, it makes the same good expensive to import which was earlier imported at a lower rate. This cannot be stopped as the imports have to take place to meet the increasing demands of an economy. This can be more easily understood through an example.

Suppose the exchange rate of 1 dollar in terms of Indian Rupees is 45. Now today, 1 can of Pepsi is 1 dollar which means Rs. 45 in terms of Indian currency. Next day, INR falls by 15% making the exchange rate at Rs. 51.75. The same can of Pepsi will start costing Rs. 51.75 from the falling day onwards and this leads to inflation. There are certain causes of fall in INR, which are;

  1. Investors pull out their investments from the economy to invest in other economies due to economic and non-economic reasons. By such economic activity of investors, it leads to a fall in the demand for INR, which ultimately results in the fall of the INR’s value, too.
  2. Political disturbances in the country also reduce the demand for the INR.
  3. Issues such as a high rate of inflation also bring down the value of the INR.
  4. Stability and insurance of returns on investments assured in other parts of the global economy.
  5. Deliberate depreciation by the central bank, etc.[vii]

Some ways have to be thought of to tackle with such causes of INR weakness so that it does not result into inflation towards the end.

5. Cost of output heading to north

Another important thing which is rising in the northwards direction is the cost of output. Now, because the input has gone so costly, to cope up with that that prices of the final products have to be increased. There are various other factors too which results in the increasing cost of output and these are;

  1. As the population is increasing all the time, so is the demand for land which results in increase of final price of manufactured goods.
  2. Cost of labor is rapidly stepping up to meet the level of inflated goods and services.
  3. Rise in profit margins of producers.
  4. Increase in the cost of marketing has also risen because of growing competition.

Studying these causes and their effects on the economy, it seems that all of them are interlinked in some way or another. The bigger point is that these problems are not those which could not be tackled by human agencies, but the only point is that right minds have to be applied to understand them and finally work upon solving them.

Types of Inflation

Now as we have studied the cause and effect relationship of inflation, I think it’s the right time to discuss various types of inflation which have been laid down by various economists. These types are those which fall in the category of the most basic ones and are as following;

  1. Hyperinflation – This is the most extreme of the inflation phenomenons as its name suggests. This is the type with yearly price increases of three-digit percentage points and an explosive acceleration. In other terms, it can be called as an out-of-control inflationary spiral.
  1. Extremely high inflation – This ranges from anywhere between 50% to 100%. High inflation is a situation of price increase of, say, 30%-50% a year. Both kinds can be stable or dangerously accelerate to enter in a hyperinflation condition.[viii]
  1. Moderate inflation – This is differently defined around the world, given the different inflation histories. As an indication only, one could consider inflation as moderate when it ranges from 5% to 25-30%. For some countries, the higher part of this range is already “high inflation”.
  1. Low inflation – The last one in the list. This can be characterized from 1-2% to 5%. Around zero there is no inflation (price stability). Below zero, a country faces deflation.[ix]

The types of inflation have been discussed and described variably by different people depending upon their own understanding of the terms. But this is the one which is most precise and generally accepted understanding of the basic types of inflation.

Not just the definitions, but the types themselves have been named and listed variably. Some people have even tried to make 2 page long lists of types of inflation depending upon various circumstances.

CPI and Inflation

CPI is another very often heard term in relation to Inflation. Whenever there is a talk going on about inflation, CPI has to be one of the topics to be discussed to make the discussion fruitful and complete in all forms. CPI is basically a measuring element for calculating the inflation rate of whatever country you take.

Because CPI represents a number that is the most widely used measure of inflation, most people think that CPI and inflation are one in the same. But CPI itself does not tell us what the current inflation rate is. Calculations using the index must be done in order to determine the increase or decrease in the prices of goods and services.[x]

The ‘rate of inflation’ or the ‘inflation rate’ is generally calculated by calculating the change or movement of price indexes. This price index is usually the Consumer price index.The consumer price index measures movements in prices of a fixed basket of goods and services purchased by a “typical consumer”.[xi]

Inflation Rate – It is the percentage rate of change of a price index over time.

{CPI inflation (year-on-year) in the United States from 1914 to 2010}

Unlike India, the measure of inflation that is commonly used in the United Kingdom is the RPI (Retail Prices Index). RPI is much broader than CPI in its approach and works on a larger basket of goods and services. I will be illustrating a method of calculation below, which has been taken from Wikipedia.

To illustrate the method of calculation, in January 2007, the U.S. Consumer Price Index was 202.416, and in January 2008 it was 211.080. The formula for calculating the annual percentage rate inflation in the CPI over the course of 2007 is

The resulting inflation rate for the CPI in this one year period is 4.28%, meaning the general level of prices for typical U.S. consumers rose by approximately four percent in 2007.[xii]

There are some other widely accepted indices too which are used for calculating the price inflation. These measures are;

  1. Producer Price Indices (PPI’s)
  2. Commodity Price Indices
  3. Core Price Indices

These measures are also generally accepted measures like CPI in India and USA and RPI in UK, as mentioned above.

Talking about the long-term trends in inflation, world-wide inflation was on its peak in the ’70s, because of two oil crises. Afterwards, inflation has become a major target of public powers and it has been decelerating in most countries.

Nonetheless, significant episodes of hyperinflation are still common and many stagnating economies can’t take off both because of inflation and anti-inflationary policies.[xiii]

Conclusion

Inflation, being an issue of utmost importance to the economic growth of a country should be taken very seriously. The simple reason for this being that people will only be able to contribute in such issues, if they understand such topics from their grass root level. This is very much important because there is a need for contributions to be made by the general population too rather than just the policy makers sitting in their AC Chambers and discussing for the whole country.

Formatted on 18th February 2019.

References

[i] http://www.economicshelp.org/macroeconomics/inflation/definition.html

[ii] http://en.wikipedia.org/wiki/John_Maynard_Keynes

[iii]http://www.studyssconline.com/content/standard_X/geography_economics/Meaning_and_Causes_Of_Inflation%20Demo.pdf

[iv] http://www.preservearticles.com/201012281822/features-of-inflation.html

[v] http://theglobalecon.com/key-causes-of-inflation-in-india/

[vi] http://theglobalecon.com/key-causes-of-inflation-in-india/

[vii] http://theglobalecon.com/key-causes-of-inflation-in-india/

[viii] http://www.economicswebinstitute.org/glossary/inflat.htm#basic

[ix] http://bhanusigdel.wordpress.com/2011/11/26/inflation-and-its-types/

[x] http://www.inflation-linked.com/difference.html

[xi]  Mankiw 2002, pp. 22–32

[xii] http://en.wikipedia.org/wiki/Inflation#cite_note-34

[xiii] http://www.economicswebinstitute.org/glossary/inflat.htm#long

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