Inflation can be defined as the eventual loss of buying power of a particular currency. A quantitative measure of the pace at which buying power declines can be expressed in the growth in an economy’s average price level of a basket of selected goods and services over time. An increase in the overall level of prices, generally represented as a percentage, indicates that a unit of money buys less than it did previously. Inflation is distinguished from deflation, which happens when the buying power of money rises but prices fall.
What is Inflation and What Causes It?
Inflation is caused by a rise in the quantity of money, which can occur through many causes in the economy. The monetary authorities can increase the money supply by printing and distributing more money to individuals, legally devaluing (decreasing the value of) the legal tender currency, or more commonly (and most commonly) by lending new money into existence as reserve account credits through the banking system by purchasing government bonds from banks on the secondary market.
In all instances where the money supply is increased, the money loses buying power. There are three sorts of processes that cause inflation: demand-pull inflation, cost-push inflation, and built-in inflation.
Demand-pull Inflation happens when an increase in the availability of money and credit causes an economy’s total demand for goods and services to rise faster than the economy’s production capability. This raises demand and, as a result, prices.
With more money accessible to individuals, a better consumer mood leads to more expenditure, which drives up prices. It causes a demand-supply imbalance, with more demand and less flexible supply, resulting in higher prices.
Cost-push inflation occurs as a result of price increases in manufacturing process inputs. Costs for all types of intermediate products rise when increases in the supply of money and credit are funneled into a commodity or other asset markets, especially when this is accompanied by a negative economic shock to the supply of essential commodities.
These advances raise the cost of the final product or service, which in turn raises consumer pricing. For example, when the money supply expands and causes a speculative boom in oil prices, the cost of energy for all purposes might rise, contributing to rising consumer prices, which is reflected in various measures of inflation.
Built-in inflation is linked to adaptive expectations or the belief that present inflation rates will persist in the future. Workers and others learn to assume that when the price of products and services grows, they will continue to climb at a similar rate in the future and demand higher expenses or salaries to maintain their level of living. Their greater earnings raise the cost of products and services, and the wage-price spiral continues as one component induces the other and vice versa.
Inflation Rate Meaning and Formula
The inflation rate is the percentage rise or reduction in prices over a given time period, which is often a month or a year. The percentage indicates how rapidly prices increased during the period.
The difference between the initial and final CPIs divided by the starting CPI is the inflation rate formula. The value is then multiplied by 100 to calculate the inflation rate.
Rate of Inflation = (Initial CPI – Final CPI/ Initial CPI)*100
CPI= Consumer Price Index
The Consumer Price Index is used to calculate inflation (CPI). By following these procedures, you may determine inflation for any product.
- Determine the product’s rate at a previous time.
- Determine the product’s current rate.
- In order to get the inflation rate, multiply (Initial CPI – Final CPI/Initial CPI)*100. In this case, CPI is the product’s rate.
- This provides the % increase/decrease in the product’s price. This may be used to compare the inflation rate throughout time.
Also Read: How Does Inflation Impact the Stock Market
Effects of Rising Inflation Rate
A rise in the inflation rate can result in more than just a loss of purchasing power.
- Inflation may lead to economic growth since it is an indication of growing demand.
- Inflation might lead to more cost increases as workers demand salary increases to keep up with inflation. This might lead to an increase in unemployment if businesses are forced to lay off people in order to meet the expenditures.
- Domestic products may become less competitive if the country’s inflation rate rises. It has the potential to depreciate the country’s currency.
Types of Inflation
On the Base of Cause
(i) Currency inflation:
The production of currency notes causes this sort of inflation.
(ii) Credit inflation:
Commercial banks, being profit-making organizations, provide more loans and advances to the public than the economy requires. Price levels grow as a result of such credit expansion.
(iii) Deficit-induced inflation:
When government expenditure surpasses revenue, the budget is in deficit. To close the deficit, the government may request that the central bank issue more money. Because more money must be pumped into the economy to cover the budget deficit, any price increase may be referred to as deficit-induced inflation.
(iv) Demand-pull inflation:
A rise in the price level results from an increase in aggregate demand over available output. This type of inflation is known as demand-pull inflation (henceforth DPI).
(v) Cost-push inflation:
Inflation in an economy can occur as a result of an increase in the overall cost of manufacturing. Cost-push inflation is the name given to this form of inflation (henceforth CPI). The cost of production may rise when the price of raw materials, salaries, and so on rises.
On the Base of Intensity
(i) Creeping or Mild Inflation:
If the rate of price rise is gradual yet significant, we get creeping inflation. Economists have not indicated what rate of yearly price growth is a creeping one. Some define creeping or moderate inflation as yearly price increases ranging between 2% and 3%. If the pace of price growth remains at this level, it is thought to be beneficial to economic progress. Others believe that if yearly price increases are little more than 3%, there is no concern.
(ii) Walking Inflation:
Walking inflation occurs when the yearly rate of price growth falls between 3 and 4%. Walking inflation develops when modest inflation is allowed to fan out. These two forms of inflation are referred to as “moderate inflation.”
(iii) Galloping and Hyperinflation:
Running inflation may be converted from walking inflation. Running inflation is risky. If it is not managed, it may eventually lead to galloping or hyperinflation. When an economy is shattered, it results in an extreme type of inflation.
(iv) Government’s Reaction to Inflation:
The inflationary condition might be open or closed. Because of the government’s anti-inflationary efforts, inflation may not be an embarrassing one.
What is Inflation – FAQs
Q1. What is the inflation definition?
Inflation is the gradual loss of buying power of a particular currency. A quantitative measure of the pace at which buying power declines can be expressed in the growth in an economy’s average price level of a basket of selected goods and services over time.
Q2. What are the benefits of inflation?
Inflation, while a source of concern for the economy, does not have a negative impact on everyone. It is a blessing for a specific group of individuals. While inflation reduces consumers’ purchasing power, it benefits investors.
Investors who invest in inflation-affected assets will almost definitely gain if they hold them for a long period. A rise in property costs, for example, may have an impact on consumers. Those who have already purchased a home, on the other hand, will profit from capital appreciation.
Q3. How to prevent inflation?
The basic approach for preventing inflation is to modify monetary policy by changing interest rates. Higher interest rates reduce the economy’s demand. This leads to slower economic growth and, as a result, reduced inflation. Other methods of preventing inflation include:
- Controlling the money supply can also assist to keep inflation at bay.
- Increased income taxation can limit expenditure, resulting in lower demand and inflationary pressures.
- Introducing strategies to enhance the economy’s efficiency and competitiveness aids in the reduction of long-term expenses.
Q4. What are the types of inflation?
Demand-pull inflation, cost-push inflation, and built-in inflation are the three forms of inflation.
Q5. What is the formula to measure inflation?
Mathematically, the formula to measure inflation is:
Percent inflation rate = (Final CPI Index Value/Initial CPI Value)*100