Definition of Inflation
Inflation is defined as a sustained increase in the general price level of goods and services
in an economy over a specific period. It reflects a reduction in the purchasing power of
money, meaning each unit of currency buys fewer goods and services. Economists
describe inflation as a loss of real value in the medium of exchange and unit of account in
the economy. Various definitions of inflation have been proposed by different economists,
including:
1. 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.”
2. Coulborn: Defines inflation as “too much money chasing too few goods.”
3. Samuels-Nordhaus: States that inflation is a rise in the general level of prices.
4. Johnson: Suggests that inflation is an increase in the quantity of money faster than real
national output is expanding.
5. Keynes: Believes true inflation occurs when the elasticity of supply of output is zero in
response to an increase in the supply of money.
Types of Inflation
Inflation can be categorized based on various criteria, including its rate and underlying
causes.
A. On the Basis of Rate
1. Creeping Inflation: Also known as mild inflation, this type is characterized by a slow rise
in prices, typically less than 3% per annum. It is seen as manageable and can stimulate
economic growth.
2. Chronic Inflation: Persistent creeping inflation over time leads to chronic inflation. This
prolonged inflation can escalate into more severe forms if not addressed.
3. Walking or Trotting Inflation: Defined as moderate inflation with annual price increases
between 3% and 10%, walking inflation is often manageable but signals potential
economic issues.
4. Running Inflation: This refers to rapid price increases exceeding 10% per annum,
indicating a worrying trend in inflation rates.
5. Galloping Inflation: Characterized by double or triple-digit inflation rates (more than 20%
but less than 1000%), galloping inflation signifies severe economic instability.
6. Hyperinflation: An extreme form of inflation where prices soar at rates exceeding 1000%
per annum. In cases of hyperinflation, the currency loses its value, leading to barter
systems in some economies. Notable historical examples include Hungary in 1946 and
Zimbabwe between 2004 and 2009.
B. On the Basis of Causes
1. Demand-Pull Inflation: Occurs when aggregate demand outstrips the supply of goods
and services, leading to increased prices as demand outpaces supply.
2. Cost-Push Inflation: Results from rising costs of production (e.g., higher wages,
increased raw material prices), which cause suppliers to raise their prices to maintain
profit margins.
3. Monetary Factors: An increase in the money supply without a corresponding increase in
goods and services can lead to inflation, as more money chases the same amount of
products.
4. External Factors: Changes in global markets, such as fluctuating commodity prices or
exchange rates, can also impact inflation rates domestically.
Effects of Inflation
Inflation has both positive and negative effects on the economy.
Positive Effects
1. Rise in Profit: Businesses often experience increased profits during inflationary
periods, incentivizing investment and economic expansion.
2. Increased Production: Moderate inflation can encourage production as businesses
respond to rising prices with increased output to capitalize on profit opportunities.
3. Financing Opportunities: Companies can finance growth through the sale of shares,
benefiting from investor confidence amid inflationary conditions.
4. Debtors Gain: Borrowers benefit from inflation as the real value of fixed debts
decreases, allowing them to repay loans with less valuable currency.
5. Moderate Increases in Output and Employment: Mild inflation may lead to more job
creation as businesses expand operations to meet rising demand.
Negative Effects
1. Decrease in Real Income: Inflation erodes the purchasing power of income,
particularly affecting those with fixed incomes, such as retirees.
2. Discouraging Savings: High inflation discourages savings as the value of money
declines over time, leading individuals to spend rather than save.
3. Discouraging Efficiency: Businesses may become complacent during inflation,
reducing their focus on cost control and efficiency.
4. Reduced Standard of Living: Inflation can lead to a lower standard of living as prices
for essential goods rise faster than wages.
5. Creditor Losses: Creditors suffer during inflation since the real value of the money
they are repaid declines, reducing their returns.
Measurement of Inflation
Inflation can be measured using various indices:
1. Consumer Price Index (CPI): This index tracks changes in the prices of a basket of
consumer goods and services, serving as a primary indicator of inflation.
2. Producer Price Index (PPI): Measures the average changes in prices received by
domestic producers for their goods, reflecting cost changes upstream in the
production process.
3. Gross Domestic Product (GDP) Deflator: Compares nominal GDP to real GDP,
measuring overall price changes across the economy and providing insight into
inflation’s impact on economic growth.
4. Core Inflation: This measure excludes volatile items, such as food and energy
prices, to provide a clearer picture of underlying inflation trends.
Control of Inflation
Various strategies can be employed to control inflation:
1. Monetary Policy: Central banks can raise interest rates or reduce the money supply
to curb inflationary pressures.
2. Fiscal Policy: Governments can decrease spending or increase taxes to lower
aggregate demand and combat demand-pull inflation.
3. Supply-Side Measures: Increasing production capabilities and improving supply
chains can help stabilize prices and alleviate inflationary pressures.
4. Wage and Price Controls: Temporary controls on wages and prices can limit inflation
but may lead to shortages and reduced incentives for production.
5. Increasing Production: Enhancing productivity through modernization and
technology can help meet demand without triggering inflation.
6. Agricultural Output: Increasing agricultural production can help stabilize food
prices, which often drive inflation.
7. Rationing Scarce Commodities: Rationing can control demand during periods of
high inflation, though it may lead to inefficiencies.
8. Wage Freezes: Temporarily freezing wages can prevent wage-push inflation, though
it can also lead to dissatisfaction among workers.
9. Avoiding Industrial Strikes: Maintaining labor peace can help prevent wage pressure
which cause inflation.
