Inflation

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Inflation is a rate at which the price of a basket of goods or services increases over a period of time. In other words, inflation can be defined as an increase in the price of goods or a decrease in the value or purchasing power of money. 

For example, Goods that could have been bought for USD 100 in 1956 can be bought today for USD 960. In other words USD 100 in 1956 has purchasing power worth USD 10.42 today.

The basic cause of inflation is the rise in the price of goods in the market which can be caused by various factors. Based on these factors inflation can be categorized as:

Demand-Pull Inflation

  • When the demand for a product is higher than the supply of that product leading to a rise in its price is termed as a Demand-Pull Inflation.
  • This can happen because of either increase in the demand or a decrease in the supply of the product which further leads to an increase in the prices.
  • For example, when onion crops fail in a particular season, the prices of onion rise in the market because the supply remains limited.

Cost-Push Inflation

  • An increase in the production cost of goods caused due to increase in the cost of raw material, cost of wages, and other production costs can be termed as Cost-Push Inflation.

Built-in Inflation

  • As the price of goods increases in an economy, the labour or employees demand more wages to maintain their cost of living. The increase in wages will further lead to an increase in the cost of goods increasing the price of these goods. This circular impact is known as built-in inflation.

Effects on Inflation

Inflation may have the following positive impact:

  • Inflation demotes hoarding of cash as the value of money is continuously decreasing.
  • Further, it promotes investment in the economy.

However, inflation may also have the following negative impact:

  • High or negative inflation may have a negative impact on the economy
  • Increase in unemployment
  • A decrease in business investment
  • Change in the rate of foreign currencies
  • Hoarding of necessary items in the market

There are 2 other concepts related to inflation, Deflation, and Hyperinflation. Let us understand them as well.

Deflation

  • Deflation is a situation contrary to inflation in which prices are continuously decreasing with time. 
  • Deflation is worse than inflation as people would restrain themselves from buying goods as prices would be lesser in the future.
  • This can push an economy into a state of recession.

Hyperinflation

Hyperinflation is generally described as a situation where the monthly inflation rate is 50% or more. This can occur in a situation of:

  • War,
  • Recession, or
  • When central banks are printing an excessive amount of money

Many countries have seen hyper-inflation such as:

S. No.Name of the countryYearHighest monthly inflation rateTime in which prices double
1Germany192329,500%3.7 Days
2Greece194413,800%4.3 Days
3Hungary1945-194641,900,000,000,000,000%15 Hours
4Yugoslavia1992-1994313,000,000%1.41 Days
5Zimbabwe200879,600,000,000%24.7 Hours
6Venezuela2016-ongoing234%18 days
  • In 2008, hyperinflation was seen in Zimbabwe where prices of goods would double every 24 hours.
  • In 2009, the govt. issued a 1 trillion dollar note which was equivalent to USD 1 in that time
  • The latest ongoing incident of hyperinflation is in Venezuela where the price of goods double every 18 days

Conclusion: Whether inflation is good or bad for an economy

  • An optimum level of inflation is necessary to promote spending,
  • If there is no inflation, there may be no difference in savings and spending,
  • This may limit spending, which may decrease money circulation and will slow the overall activities in the country.

Thus, a balanced approach is required to keep the inflation rate in an optimum and desirable range.

Basis economists, this optimum range is as follows:

  • Developed Countries – 2% per annum
  • Developing Countries – 2 – 6% per annum

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