Inflation

Inflation

is

commonly

understood

as

situation

of

substantial and rapid general increase in the price level and

consequent fall the value of money over a period of time.
Inflation means persistent rise in the general level of prices.
Crowther defines inflation as a state in which the value of
money is falling, i.e. prices are rising. Prof. Samuelson
defines Inflation occurs when the general level of prices
and costs is rising.
Demand Pull Inflation: Demand-pull inflation or excessdemand inflation may be defined as a situation where the
total monetary demand exceeds the total supply of real
goods and services at current prices, so that prices are
pulled upwards by the continuous upward shift of the
aggregate demand function. According to the demand-pull
theory, prices rise in response to an excess of aggregate
demand over existing supply of goods and services. In the
excess-demand theory of inflation, excess demand means
aggregate real demand for output is excess of maximum
feasible or potential or full employment level output. The
demand-pull theorists point out that demand-pull inflation
might be caused, in the first place, by an increase in the
quantity of money. Causes of demand-pull inflation are 1)

Increase in public expenditure 2) Increase in investment 3)

Increase in money supply.
Cost Push Inflation: Cost push inflation or cost inflation is
induced by the wage-inflation process. This is especially
true for a country like India, where labour intensive
techniques are commonly used. Theories of cost-push
inflation

were

put

forward

after

the

mid-1950s.They

appeared largely in refutation of the demand-pull theories

of inflation. Two important common ingredients of such
theories are 1) that the upward push in costs is autonomous
of the demand conditions in the concerned market 2) that
the push forces operate through some important cost
component such as wages, profits or materials cost.
Accordingly, cost-push inflation can have

the forms of

wage-push inflation, profit-push inflation, material-cost push

inflation, or inflation of a mixed variety in which several
push factors reinforce each other and that the increase in
costs is passed on to buyers of goods in the form of higher
prices. Thus, a rise in wages leads to a rise in the total cost
of production and a consequent rise in the price level. It has
been said that a rise in wages causing a rise in prices may,
in turn, generate an inflationary spiral because an increase
would motivate the workers to demand more wages.
Common causes of Inflation

1) Excess Money Supply: Many a times a remarkable

degree of correlation between the increase in money
and rise in the price level may be observed. The
Central Bank (RBI in India) should maintain a balance
between money supply and production and supply of
goods and services in the economy. When money
supply exceeds the availability of goods and services in
the economy, it would lead to inflation.
2) Increase in Population: Increase in population leads
to increased demand for goods and services. If supplies
of commodities are short, increased demand will lead
to increase in price and inflation.
3) Expansion of Bank Credit: Rapid expansion of bank
credit is also responsible for the inflationary trend in a
country.
4) Deficit Financing: The high doses of deficit financing
i.e. spending more than revenue, may also contribute
to the growth of the inflationary spiral in a country.
5) High Indirect Taxes: Prices tend to rise on account of
high excise duties and taxes (direct and indirect)
imposed by the Government on raw materials and
essentials.
6) Black Money: It is widely condemned that black
money in the hands of tax evaders and black marketers
is an important source of inflation. Black money

encourages lavish spending, which causes excess

demand and a rise in prices.
7) Poor Performance of Farm Sector: If agricultural
production especially food grains production is very
low, it would lead to shortage of food grains which lead
to inflation.
8) Other

reasons

entrepreneurial

such

as

capital

bottlenecks,

bottleneck,

infrastructural

bottlenecks and foreign exchange bottlenecks.

Effects of Inflation
1) Business

Community:

Inflation

is

welcomed

by

entrepreneurs and businessmen because they stand to

profit by rising prices. They find that the value of their
inventories and stock of goods is rising in money
terms. They also find that prices are rising faster than
the costs of production, so that their profit is greatly
enhanced.
2) Fixed Income Groups: Inflation hits wage-earners and
salaried people very hard. Although wage-earners, by
the grace of trade unions, can chase galloping prices,
they seldom win the race. Since wages do not rise at
the same rate and at the same time as the general
price level, the cost of living index rises, and the real
income of the wage earner decreases.

3) Farmers:

Farmers

usually

gain

during

inflation,

because they can get better prices for their harvest

during inflation.
4) Investors: Those who invest in debentures and fixedinterest bearing securities, bonds etc. lose during
inflation.

However,

investors

in

equities

benefit

because more dividend is yielded on account of high

profit made by joint-stock companies during inflation.
5) Inflation will lead to deterioration of gross domestic
savings and less capital formation in the economy and
less long term economic growth rate of the economy.
Measures to Control Inflation
The measures to control inflation can be broadly divided
into two namely monetary and fiscal measures.
Monetary Measures
Inflation is primarily a monetary phenomenon. Hence, the
most logical solution to check inflation is to check the flow
of money supply by devising appropriate monetary policy
and

carefully

implementing

monetary

measures.

The

Central banks monetary management methods, devices for

decreasing or increasing the supply of money and credit for
monetary stability is called monetary policy. Monetary
policy is a policy of money supply influencing the quantity,

cost and availability of money supply. Central Banks

generally use the three quantitative measures namely:
1) Bank Rate Policy: Bank rate is the rate at which

Central Bank lends loans and advances to commercial

banks. When bank rates are hiked by the Central bank
as a follow up of this increased bank rate, commercial
banks hike the rate of interest. Bank rate is hiked
during the period of inflation to reduce money supply.
During the period of falling prices (deflation) central
banks reduces bank rate to increase money supply. As
follow up, commercial banks reduce rate of interest. At
a low rate of interest, investors find it much attractive
to borrow money and make investment.
2) Open market Operations: Open market Operation

means

open

securities

by

buying
the

and

Central

selling
Bank

of
for

government
the

Central

Government. In India the term stands for the purchase

and sale of government securities by the RBI from/to
the public and banks on its own account. In its capacity
as the governments banker and as the manager of
public debt, the RBI buys all the unsold stock of new
government loans at the end of the subscription period
and thereafter keeps them on sale in the market on its
own account. Such purchases of government securities
by the RBI are not genuine market purchases but

constitute only an internal arrangement between the

government and the RBI whereby the new government
loans are sold not directly by the government but
through the RBI as its agent.
3) Variable

enacted

Reserve Ratio: Under the existing law

in

1956,

RBI

is

empowered

to

impose

statutorily Cash Reserve Ratio (CRR) on commercial

banks anywhere between 3 per cent and 15 per cent of
the net demand and time liabilities. It is the authority
of the RBI to vary the minimum CRR which makes the
variable reserve ratio a tool of monetary control. It
may be noted that the RBI pays interest to banks on
the additional required reserves over the minimum
CRR of 3 per cent.
Fiscal Measures
Fiscal policy is the policy of the government implementing
through

the

intervention

government
areas

are

treasuries.

taxation,

public

Fiscal

policy

expenditure,

borrowing, subsidies and deficit financing. Inflation means a

general rise in prices. To control inflation, policy should be
directed to reduce the price level and control excess money
supply. First measure is reducing indirect taxes. High
indirect taxes lead to increase in the prices of goods and
services. So to reduce the prices of goods and services
widely used by common people and intermediate goods, the

indirect

taxes

should

be

reduced.

Increased

public

expenditure leads to increase in the level of economic

activities and more income to people. It also leads to
increase in money supply. So during the period of inflation,
we

should

reduce

excess

public

spending

or

public

expenditure.

Selective Credit Control Measures

Selective Credit Controls (SCCs) are used in the western
countries for such purposes as regulating stock market
credit or credit for consumer durables. In India such
controls have been used mainly to prevent speculative
hoarding of essential commodities like food grains and
agricultural raw materials to check an undue rise in their
prices. The degree of success of SCCs will depend upon
several factors, stated below;
1) The extent of effective credit restrictions
2) The availability of non-bank finance
3) The degree of shortfall in supply in relation to normal
demand
The RBI operates the SCCs under the directive powers
conferred on it by the banking Act. The technique of SCCs
used generally is:
1) Minimum margins for lending against securities.

2) Ceiling on maximum advances to individual borrowers

against stocks of certain commodities;
3) Minimum discriminatory rates of interest prescribed
for certain kinds of advances
4) Prohibition of clean advances for financing hoarding of
sensitive commodities; and
5) Prohibition of the discounting of bills covering sale of
sensitive commodities.
Deflation
Deflation is just opposite of inflation. It is essentially a
matter of falling prices. Deflation is that state of falling
prices when the output of work by productive agents
increases relatively to money income. Deflation arises when
the total expenditure of the community is not equal to the
value of output at existing prices. Consequently, the value of
money goes up, and prices fall. In short, deflation is a
condition of falling prices, accompanied by the decreasing
level of employment, output and income.
Inflation versus Deflation
Inflation is unjust, deflation is inexpedient. Both inflation
and deflation are socially bad, but inflation may be
considered to be lesser of the two evils.
Inflation is unjust in its effects on the following counts:

1) Inflation redistributes income in favour of the rich and

profiteer class at the cost of the poor masses- the wage
earners and consumers.
2) Through its redistributive effects, inflation increases
the inequality of income in the community by widening
the gulf between higher income groups and lower
income groups. The rich become richer and the poor
become poorer during inflation.
3) Inflation is regressive in effect in the sense that it hits
hard those who are already weak and cannot protect
themselves. It is specially the middle class which
suffers most due to the inflation.
4) Inflation is unjust because it affects different people
and classes in society in different ways and to different
degrees. If inflation were to affect everyone in society
in exactly the same manner and to the same degree, it
would not alter economic and social relationships in
the community. But inflation takes away wealth from
some people and transfers it to others arbitrarily
without taking into consideration the sound maxim of
social equity.
5) Inflation is also unjust because it breaks public morale.
From the point of view of social ethics, inflation is
always

demoralizing.

gambling.

It

It

promotes

introduces
speculation,

the

spirit

hoarding

of
and

diverts business skill and efficiency from productive

purposes to speculative purposes
6) Inflation erodes real savings by deterioration of the
value of money.
7) Inflation creates money illusion and generates artificial
prosperity which is not permanent.