Is Inflation a Necessary Evil?
Inflation measures how much more expensive a set of goods and services has become over a certain period, usually a year. A sustained rise in the prices of commodities that leads to a fall in the purchasing power of a nation is called Inflation. Inflation is often defined in terms of its supposed causes. Inflation exists when the money supply exceeds available goods and services. This is a big problem that plagues all economies.
In economics, inflation is a rise in the general level of prices of goods and services, in an economy over some time. When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money.
TYPES OF INFLATION
- Currency Inflation: This type is caused by the printing of currency notes.
- Credit Inflation: As profit-making institutions, commercial banks sanction more loans and advances to the public than the economy needs. Such credit expansion leads to a rise in the price level.
- Deficit-Induced Inflation: The government’s budget reflects a deficit when expenditure exceeds revenue. To meet this gap, the government may ask the central bank to print additional money. Since the pumping of additional money is required to meet the budget deficit, any price rise may be called deficit-induced inflation.
- Demand-Pull Inflation: An increase in aggregate demand over the available output leads to a rise in the price level. Such inflation is called demand-pull inflation (henceforth DPI).
- Cost-Push Inflation: Inflation in an economy may arise from the overall increase in the cost of production. This type of inflation is known as cost-push inflation. The cost of production may rise due to an increase in the price of raw materials, wages, etc.
CAUSES
Inflation is caused by the failure of aggregate supply to equal the increase in aggregate demand.
- Increase In Money Supply: Increased money supply will result in increased aggregate demand.
- Deficit Financing: When the government is unable to raise adequate revenue for its expenditure, it resorts to deficit financing
- Increase In Government Expenditure: This will increase the money supply in the economy will increase the aggregate demand and in turn cause inflation.
- Rise In Administered Prices: In our economy, a large part of the market is regulated by government action. There are several important commodities, both agricultural and industrial, for which the price level is administered by the government. The government keeps on raising prices from time to time to cover losses in the public sector. This policy leads to cost-push inflation.
- Rising Import Prices: Inflation has been a global phenomenon. International inflation gets imported into the country through major imports like fertilisers, edible oil, steel, cement, chemicals, and machinery. The increase in the import price of petroleum has been most spectacular and its contribution to domestic price rise is very high.
- Rising Taxes: To raise additional financial resources, the government is spending more and more on indirect taxes such as excise duties and sales tax. These taxes invariably raise the price level.
IMPACT
(a) Effects of Inflation on Income and Wealth Distribution:
- Creditors and Debtors: Borrowers gain and lenders lose during inflation because debts are fixed in rupee terms. When debts are repaid their real value declines by the price level increase and, hence, creditors lose.
- Bond and Debenture-Holders: These people suffer a reduction in real income when prices rise. In other words, the value of one’s savings declines if the interest rate falls short of the inflation rate.
- Investors: People who put their money in shares during boom are expected to gain since the possibility of earning business profit brightens. Higher profit induces owners of firms to distribute profit among investors or shareholders.
- Salaried People and Wage-Earners: Inflation results in a reduction in the real purchasing power of fixed-income earners. On the other hand, people earning flexible incomes may gain during inflation.
- Profit-Earners, Speculators and Black Marketeers: Profit tends to rise during inflation. Seeing inflation, businessmen raise the prices of their products. This results in a bigger profit. The profit margin, however, may not be high when the rate of inflation climbs to a high level.
b. Effect on Production and Economic Growth:
- Inflation may or may not result in higher output. Below the full employment stage, it has a favourable effect on production.
- An inflationary situation provides an incentive to businessmen to raise the prices of their products to earn higher doses of profit.
- Rising prices and rising profits encourage firms to make larger investments.
- Inflation may also lower further production levels. It is commonly assumed that if inflationary tendencies nurtured by experienced inflation persist in future, people will save less and consume more.
- Amid rising inflationary trends, firms cannot accurately estimate their costs and revenues. Under the circumstances, business firms may be deterred from investing. This will adversely affect the growth performance of the economy.
MEASURES TO CONTROL INFLATION
Some of the important measures to control it are as follows:
1. Monetary Measures
2. Fiscal Measures
3. Other Measures.
1. Monetary Measures
Monetary measures aim at reducing money incomes.
- Credit Control: One of the important monetary measures is monetary policy. The central bank of the country adopts several methods to control the quantity and quality of credit. For this purpose, it raises the bank rates, sells securities in the open market, raises the reserve ratio, and adopts some selective credit control measures, such as raising margin requirements and regulating consumer credit.
- Demonetisation of Currency: One of the monetary measures is to demonetise currency of higher denominations. Such a measure is usually adopted when black money is abundant in the country.
- Issue of New Currency: The most extreme monetary measure is the issue of new currency in place of the old currency. Under this system, one new note is exchanged for a number of notes of the old currency. The value of bank deposits is also fixed accordingly.
2. Fiscal Measures
Fiscal measures are highly effective for controlling government expenditure, personal consumption expenditure, and private and public investment.
- Reduction in Unnecessary Expenditure: The government should reduce unnecessary expenditure on non-development activities to curb the boom. This will also put a check on private expenditure which is dependent upon government demand for goods and services.
- Increase in Taxes: To cut personal consumption expenditure, the rates of personal, corporate and commodity taxes should be raised and even new taxes should be levied, but the rates of taxes should not be so high as to discourage saving, investment and production.
- Increase in Savings: This will tend to reduce the disposable income of the people, and hence personal consumption expenditure.
- Surplus Budgets: The government gives up deficit financing and instead has surplus budgets. It means collecting more in revenues and spending less.
- Public Debt: The government should borrow more to reduce the money supply to the public.
3. Other Measures
The other types of measures are those which aim at increasing aggregate supply and reducing aggregate demand directly.
- To Increase Production: One of the foremost measures to control inflationary trend, is to increase the production of essential consumer goods like food, clothing, kerosene oil, sugar, vegetable oils, etc.
- Rational Wage Policy: Another important measure is to adopt a rational wage and income policy. Under hyperinflation, there is a wage-price spiral. To control this, the government should freeze wages, incomes, profits, dividends, bonuses, etc.
- Price Control: Price control and rationing is another measure of direct control to check the expansion. Price control means fixing an upper limit for the prices of essential consumer goods. They are the maximum prices fixed by law and anybody charging more than these prices is punished by law.
- Rationing: Rationing aims at distributing the consumption of scarce goods so as to make them available to a large number of consumers. It is applied to essential consumer goods such as wheat, rice, sugar, kerosene oil, etc. It is meant to stabilise the prices of necessities and assure distributive justice.
CONCLUSION
Inflation can be a concern because it makes money saved today less valuable tomorrow. Inflation erodes a consumer’s purchasing power. High inflation rates have an adverse effect on the GDP, decreasing the purchasing power of money and leading to a drop in national output. To control inflation, the government should adopt all measures simultaneously.
However, a slight dose of inflationary trend, is necessary for economic growth. Mild inflation has an encouraging effect on national output. But it is difficult to make the price rise of a creeping variety. A high rate of inflation acts as a disincentive to long-run economic growth.
Written By: Tanishka Ranjan
Mail us at edumoundofficial@gmail.com
