1/25/2017 Inflation:Types,CausesandEffects(WithDiagram)

EconomicsDiscussion

Inflation:Types,
CausesandEffects
(WithDiagram)
ArticleSharedby

Inflationandunemploymentarethetwomost
talkedaboutwordsinthecontemporary
society.

Thesetwoarethebigproblemsthatplagueall
theeconomies.

ADVERTISEMENTS:

Almosteveryoneissurethatheknowswhat
inflationexactlyis,butitremainsasourceof
greatdealofconfusionbecauseitisdifficultto
defineitunambiguously.

1.MeaningofInflation:
Inflationisoftendefinedintermsofits
supposedcauses.Inflationexistswhenmoney
supplyexceedsavailablegoodsandservices.Or
inflationisattributedtobudgetdeficit
financing.Adeficitbudgetmaybefinancedby
theadditionalmoneycreation.Butthesituation
ofmonetaryexpansionorbudgetdeficitmay
notcausepriceleveltorise.Hencethedifficulty
ofdefininginflation.

Inflationmaybedefinedasasustainedupward
trendinthegenerallevelofpricesandnotthe
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priceofonlyoneortwogoods.G.Ackley
definedinflationasapersistentand
appreciableriseinthegeneralleveloraverage
ofprices.Inotherwords,inflationisastateof
risingprices,butnothighprices.

Itisnothighpricesbutrisingpricelevelthat
constituteinflation.Itconstitutes,thus,an
overallincreaseinpricelevel.Itcan,thus,be
viewedasthedevaluingoftheworthofmoney.
Inotherwords,inflationreducesthepurchasing
powerofmoney.Aunitofmoneynowbuysless.
Inflationcanalsobeseenasarecurring
phenomenon.

Whilemeasuringinflation,wetakeintoaccount
alargenumberofgoodsandservicesusedby
thepeopleofacountryandthencalculate
averageincreaseinthepricesofthosegoods
andservicesoveraperiodoftime.Asmallrise
inpricesorasuddenriseinpricesisnot
inflationsincetheymayreflecttheshortterm
workingsofthemarket.

Itistobepointedoutherethatinflationisa
stateofdisequilibriumwhenthereoccursa
sustainedriseinpricelevel.Itisinflationifthe
pricesofmostgoodsgoup.Suchrateof
increasesinpricesmaybebothslowandrapid.
However,itisdifficulttodetectwhetherthereis
anupwardtrendinpricesandwhetherthis
trendissustained.Thatiswhyinflationis
difficulttodefineinanunambiguoussense.

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Letsmeasureinflationrate.Suppose,in
December2007,theconsumerpriceindexwas
193.6and,inDecember2008,itwas223.8.
Thus,theinflationrateduringthelastoneyear
was

ADVERTISEMENTS:

223.8193.6/193.6x100=15.6

Asinflationisastateofrisingprices,deflation
maybedefinedasastateoffallingpricesbut
notfallinprices.Deflationis,thus,theopposite
ofinflation,i.e.,ariseinthevalueofmoneyor
purchasingpowerofmoney.Disinflationisa
slowingdownoftherateofinflation.

2.TypesofInflation:
Asthenatureofinflationisnotuniforminan
economyforallthetime,itiswisetodistinguish
betweendifferenttypesofinflation.Such
analysisisusefultostudythedistributionaland
othereffectsofinflationaswellasto
recommendantiinflationarypolicies.Inflation
maybecausedbyavarietyoffactors.Its
intensityorpacemaybedifferentatdifferent
times.Itmayalsobeclassifiedinaccordance
withthereactionsofthegovernmenttoward
inflation.

Thus,onemayobservedifferenttypesof
inflationinthecontemporarysociety:

A.OntheBasisofCauses:
ADVERTISEMENTS:

(i)Currencyinflation:
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Thistypeofinflationiscausedbytheprintingof
currencynotes.

(ii)Creditinflation:

Beingprofitmakinginstitutions,commercial
bankssanctionmoreloansandadvancestothe
publicthanwhattheeconomyneeds.Such
creditexpansionleadstoariseinpricelevel.

(iii)Deficitinducedinflation:

Thebudgetofthegovernmentreflectsadeficit
whenexpenditureexceedsrevenue.Tomeet
thisgap,thegovernmentmayaskthecentral
banktoprintadditionalmoney.Sincepumping
ofadditionalmoneyisrequiredtomeetthe
budgetdeficit,anypricerisemaythebecalled
thedeficitinducedinflation.

(iv)Demandpullinflation:

Anincreaseinaggregatedemandoverthe
availableoutputleadstoariseinthepricelevel.
Suchinflationiscalleddemandpullinflation
(henceforthDPI).Butwhydoesaggregate
demandrise?Classicaleconomistsattributethis
riseinaggregatedemandtomoneysupply.If
thesupplyofmoneyinaneconomyexceedsthe
availablegoodsandservices,DPIappears.It
hasbeendescribedbyCoulbornasasituationof
toomuchmoneychasingtoofewgoods.

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Keynesiansholdadifferentargument.They
arguethattherecanbeanautonomousincrease
inaggregatedemandorspending,suchasarise
inconsumptiondemandorinvestmentor
governmentspendingorataxcutoranet
increaseinexports(i.e.,C+I+G+XM)with
noincreaseinmoneysupply.Thiswould
promptupwardadjustmentinprice.Thus,DPI
iscausedbymonetaryfactors(classical
adjustment)andnonmonetaryfactors
(Keynesianargument).

DPIcanbeexplainedintermsofFig.4.2,where
wemeasureoutputonthehorizontalaxisand
pricelevelontheverticalaxis.InRange1,total
spendingistooshortoffullemploymentoutput,
YF.Thereislittleornoriseinthepricelevel.As
demandnowrises,outputwillrise.The
economyentersRange2,whereoutput
approachestowardsfullemploymentsituation.
Notethatinthisregionpricelevelbeginsto
rise.Ultimately,theeconomyreachesfullem
ploymentsituation,i.e.,Range3,whereoutput
doesnotrisebutpricelevelispulledupward.
Thisisdemandpullinflation.Theessenceof
thistypeofinflationisthattoomuchspending
chasingtoofewgoods.

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(v)Costpushinflation:

Inflationinaneconomymayarisefromthe
overallincreaseinthecostofproduction.This
typeofinflationisknownascostpushinflation
(henceforthCPI).Costofproductionmayrise
duetoanincreaseinthepricesofrawmaterials,
wages,etc.Oftentradeunionsareblamedfor
wagerisesincewagerateisnotcompletely
marketdeterminded.Higherwagemeanshigh
costofproduction.Pricesofcommoditiesare
therebyincreased.

Awagepricespiralcomesintooperation.But,
atthesametime,firmsaretobeblamedalsofor
thepricerisesincetheysimplyraisepricesto
expandtheirprofitmargins.Thus,wehavetwo
importantvariantsofCPIwagepushinflation
andprofitpushinflation.

Anyway,CPIstemsfromtheleftward
shiftoftheaggregatesupplycurve:

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B.OntheBasisofSpeedorIntensity:
(i)CreepingorMildInflation:

Ifthespeedofupwardthrustinpricesisslow
butsmallthenwehavecreepinginflation.What
speedofannualpriceriseisacreepingonehas
notbeenstatedbytheeconomists.Tosome,a
creepingormildinflationisonewhenannual
pricerisevariesbetween2p.c.and3p.c.Ifa
rateofpriceriseiskeptatthislevel,itiscon
sideredtobehelpfulforeconomicdevelopment.
Othersarguethatifannualpricerisegoes
slightlybeyond3p.c.mark,stillthenitis
consideredtobeofnodanger.

(ii)WalkingInflation:

Iftherateofannualpriceincreaseliesbetween
3p.c.and4p.c.,thenwehaveasituationof
walkinginflation.Whenmildinflationis
allowedtofanout,walkinginflationappears.
Thesetwotypesofinflationmaybedescribedas
moderateinflation.

Often,onedigitinflationrateiscalledmoder
ateinflationwhichisnotonlypredictable,but
alsokeeppeoplesfaithonthemonetarysystem
ofthecountry.Peoplesconfidencegetlostonce
moderatelymaintainedrateofinflationgoesout

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ofcontrolandtheeconomyisthencaughtwith
thegallopinginflation.

(iii)GallopingandHyperinflation:

Walkinginflationmaybeconvertedinto
runninginflation.Runninginflationisdanger
ous.Ifitisnotcontrolled,itmayultimatelybe
convertedtogallopingorhyperinflation.Itisan
extremeformofinflationwhenaneconomygets
shattered.Inflationinthedoubleortripledigit
rangeof20,100or200p.c.ayearislabelled
gallopinginflation.

(iv)GovernmentsReactiontoInflation:

Inflationarysituationmaybeopenor
suppressed.Becauseofantiinflationarypolicies
pursuedbythegovernment,inflationmaynot
beanembarrassingone.Forinstance,increase
inincomeleadstoanincreaseinconsumption
spendingwhichpullsthepricelevelup.

Iftheconsumptionspendingiscounteredbythe
governmentviapricecontrolandrationing
device,theinflationarysituationmaybecalleda
suppressedone.Oncethegovernmentcurbsare
lifted,thesuppressedinflationbecomesopen
inflation.Openinflationmaythenresultin
hyperinflation.

3.CausesofInflation:
Inflationismainlycausedbyexcessdemand/or
declineinaggregatesupplyoroutput.Former
leadstoarightwardshiftoftheaggregate

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demandcurvewhilethelattercausesaggregate
supplycurvetoshiftleftward.Formeriscalled
demandpullinflation(DPI),andthelatteris
calledcostpushinflation(CPI).Before
describingthefactors,thatleadtoarisein
aggregatedemandandadeclineinaggregate
supply,weliketoexplaindemandpulland
costpushtheoriesofinflation.

(i)DemandPullInflationTheory:

TherearetwotheoreticalapproachestotheDPI
oneisclassicalandotheristheKeynesian.

Accordingtoclassicaleconomistsormon
etarists,inflationiscausedbyanincreasein
moneysupplywhichleadstoarightwardshift
innegativeslopingaggregatedemandcurve.
Givenasituationoffullemployment,classicists
maintainedthatachangeinmoneysupply
bringsaboutanequiproportionatechangein
pricelevel.

Thatiswhymonetaristsarguethatinflationis
alwaysandeverywhereamonetary
phenomenon.Keynesiansdonotfindanylink
betweenmoneysupplyandpricelevelcausing
anupwardshiftinaggregatedemand.

AccordingtoKeynesians,aggregatedemand
mayriseduetoariseinconsumerdemandor
investmentdemandorgovernmentexpenditure
ornetexportsorthecombinationofthesefour
componentsofaggreatedemand.Givenfull
employment,suchincreaseinaggregate
demandleadstoanupwardpressureinprices.
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SuchasituationiscalledDPI.Thiscanbe
explainedgraphically.

Justlikethepriceofacommodity,thelevelof
pricesisdeterminedbytheinteractionof
aggregatedemandandaggregatesupply.InFig.
4.3,aggregatedemandcurveisnegativesloping
whileaggregatesupplycurvebeforethefull
employmentstageispositiveslopingand
becomesverticalafterthefullemployment
stageisreached.AD1istheinitialaggregate
demandcurvethatintersectstheaggregate
supplycurveASatpointE1.

Thepricelevel,thus,determinedisOP1.Asag
gregatedemandcurveshiftstoAD2,pricelevel
risestoOP2.Thus,anincreaseinaggregate
demandatthefullemploymentstageleadsto
anincreaseinpricelevelonly,ratherthanthe
levelofoutput.However,howmuchpricelevel
willrisefollowinganincreaseinaggregate
demanddependsontheslopeoftheAScurve.

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(ii)CausesofDemandPullInflation:
DPIoriginatesinthemonetarysector.Mon
etaristsargumentthatonlymoneymattersis
basedontheassumptionthatatornearfull
employmentexcessivemoneysupplywillin
creaseaggregatedemandandwill,thus,cause
inflation.

Anincreaseinnominalmoneysupplyshifts
aggregatedemandcurverightward.This
enablespeopletoholdexcesscashbalances.
Spendingofexcesscashbalancesbythem
causespriceleveltorise.Pricelevelwill
continuetoriseuntilaggregatedemandequals
aggregatesupply.

Keynesiansarguethatinflationoriginatesinthe
nonmonetarysectorortherealsector.
Aggregatedemandmayriseifthereisan
increaseinconsumptionexpenditurefollowing
ataxcut.Theremaybeanautonomousincrease
inbusinessinvestmentorgovernmentexpendi
ture.Governmentexpenditureisinflationaryif
theneededmoneyisprocuredbythegov
ernmentbyprintingadditionalmoney.

Inbrief,increaseinaggregatedemandi.e.,in
creasein(C+I+G+XM)causespricelevel
torise.However,aggregatedemandmayrise
followinganincreaseinmoneysupplygen
eratedbytheprintingofadditionalmoney
(classicalargument)whichdrivespricesup
ward.Thus,moneyplaysavitalrole.Thatis
whyMiltonFriedmanarguesthatinflationis

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alwaysandeverywhereamonetaryphenom
enon.

Thereareotherreasonsthatmaypushag
gregatedemandand,hence,pricelevelup
wards.Forinstance,growthofpopulation
stimulatesaggregatedemand.Higherexport
earningsincreasethepurchasingpowerofthe
exportingcountries.Additionalpurchasing
powermeansadditionalaggregatedemand.
Purchasingpowerand,hence,aggregatede
mandmayalsogoupifgovernmentrepays
publicdebt.

Again,thereisatendencyonthepartofthe
holdersofblackmoneytospendmoreon
conspicuousconsumptiongoods.Suchtendency
fuelsinflationaryfire.Thus,DPIiscausedbya
varietyoffactors.

(iii)CostPushInflationTheory:

Inadditiontoaggregatedemand,aggregate
supplyalsogeneratesinflationaryprocess.As
inflationiscausedbyaleftwardshiftofthe
aggregatesupply,wecallitCPI.CPIisusually
associatedwithnonmonetaryfactors.CPI
arisesduetotheincreaseincostofproduction.
Costofproductionmayriseduetoariseincost
ofrawmaterialsorincreaseinwages.

However,wageincreasemayleadtoanincrease
inproductivityofworkers.Ifthishappens,then
theAScurvewillshifttotherightwardnot
leftwarddirection.Weassumeherethat

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productivitydoesnotchangeinspiteofan
increaseinwages.

Suchincreasesincostsarepassedonto
consumersbyfirmsbyraisingthepricesofthe
products.Risingwagesleadtorisingcosts.
Risingcostsleadtorisingprices.And,rising
pricesagainprompttradeunionstodemand
higherwages.Thus,aninflationarywageprice
spiralstarts.Thiscausesaggregatesupplycurve
toshiftleftward.

ThiscanbedemonstratedgraphicallywhereAS1
istheinitialaggregatesupplycurve.Belowthe
fullemploymentstagethisAScurveispositive
slopingandatfullemploymentstageitbecomes
perfectlyinelastic.

Intersectionpoint(E1)ofAD1andAS1curves
determinethepricelevel(OP1).Nowthereisa
leftwardshiftofaggregatesupplycurvetoAS2.
Withnochangeinaggregatedemand,this
causespriceleveltorisetoOP2andoutputto

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falltoOY2.Withthereductioninoutput,
employmentintheeconomydeclinesor
unemploymentrises.FurthershiftinAScurve
toAS3resultsinahigherpricelevel(OP3)anda
lowervolumeofaggregateoutput(OY3).Thus,
CPImayariseevenbelowthefullemployment
(YF)stage.

(iv)CausesofCostPushInflation:

Itisthecostfactorsthatpullthepricesupward.
Oneoftheimportantcausesofpriceriseisthe
riseinpriceofrawmaterials.Forinstance,by
anadministrativeorderthegovernmentmay
hikethepriceofpetrolordieselorfreightrate.
Firmsbuytheseinputsnowatahigherprice.
Thisleadstoanupwardpressureoncostof
production.

Notonlythis,CPIisoftenimportedfrom
outsidetheeconomy.Increaseinthepriceof
petrolbyOPECcompelsthegovernmentto
increasethepriceofpetrolanddiesel.These
twoimportantrawmaterialsareneededby
everysector,especiallythetransportsector.As
aresult,transportcostsgoupresultingin
highergeneralpricelevel.

Again,CPImaybeinducedbywagepush
inflationorprofitpushinflation.Tradeunions
demandhighermoneywagesasacompensation
againstinflationarypricerise.Ifincreasein
moneywagesexceedlabourproductivity,
aggregatesupplywillshiftupwardandleftward.
Firmsoftenexercisepowerbypushingpricesup

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independentlyofconsumerdemandtoexpand
theirprofitmargins.

Fiscalpolicychanges,suchasincreaseintax
ratesalsoleadstoanupwardpressureincostof
production.Forinstance,anoverallincreasein
excisetaxofmassconsumptiongoodsis
definitelyinflationary.Thatiswhygovernment
isthenaccusedofcausinginflation.

Finally,productionsetbacksmayresultin
decreasesinoutput.Naturaldisaster,gradual
exhaustionofnaturalresources,workstop
pages,electricpowercuts,etc.,maycauseag
gregateoutputtodecline.Inthemidstofthis
outputreduction,artificialscarcityofanygoods
createdbytradersandhoardersjustsimply
ignitethesituation.

Inefficiency,corruption,mismanagementofthe
economymayalsobetheotherreasons.Thus,
inflationiscausedbytheinterplayofvarious
factors.Aparticularfactorcannotbeheld
responsibleforanyinflationarypricerise.

4.EffectsofInflation:
Peoplesdesiresareinconsistent.Whentheyact
asbuyerstheywantpricesofgoodsandservices
toremainstablebutassellerstheyexpectthe
pricesofgoodsandservicesshouldgoup.Such
ahappyoutcomemayariseforsome
individualsbut,whenthishappens,otherswill
begettingtheworstofbothworlds.

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Whenpricelevelgoesup,thereisbothagainer
andaloser.Toevaluatetheconsequenceof
inflation,onemustidentifythenatureof
inflationwhichmaybeanticipatedand
unanticipated.Ifinflationisanticipated,people
canadjustwiththenewsituationandcostsof
inflationtothesocietywillbesmaller.

Inreality,peoplecannotpredictaccuratelyfu
tureeventsorpeopleoftenmakemistakesin
predictingthecourseofinflation.Inother
words,inflationmaybeunanticipatedwhen
peoplefailtoadjustcompletely.Thiscreates
variousproblems.

Onecanstudytheeffectsof
unanticipatedinflationundertwobroad
headings:

(a)Effectondistributionofincomeandwealth
and

(b)Effectoneconomicgrowth.

(a)EffectsofInflationonDistributionof
IncomeandWealth:

Duringinflation,usuallypeopleexperiencerise
inincomes.Butsomepeoplegainduring
inflationattheexpenseofothers.Some
individualsgainbecausetheirmoneyincomes
risemorerapidlythanthepricesandsomelose
becausepricesrisemorerapidlythantheir
incomesduringinflation.Thus,itredistributes
incomeandwealth.

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Thoughnoconclusiveevidencecanbe
cited,itcanbeassertedthatfollowing
categoriesofpeopleareaffectedby
inflationdifferently:

(i)Creditorsanddebtors:

Borrowersgainandlendersloseduring
inflationbecausedebtsarefixedinrupeeterms.
Whendebtsarerepaidtheirrealvaluedeclines
bythepricelevelincreaseand,hence,creditors
lose.Anindividualmaybeinterestedinbuying
ahousebytakingloanofRs.7lakhfromanin
stitutionfor7years.

Theborrowernowwelcomesinflationsincehe
willhavetopaylessinrealtermsthanwhenit
wasborrowed.Lender,intheprocess,loses
sincetherateofinterestpayableremains
unalteredasperagreement.Becauseof
inflation,theborrowerisgivendearrupees,
butpaysbackcheaprupees.However,ifinan
inflationriddeneconomycreditorschronically
loose,itiswisenottoadvanceloansortoshut
downbusiness.

Neverdoesithappen.Rather,theloangiving
institutionmakesadequatesafeguardagainst
theerosionofrealvalue.Aboveall,banksdo
notpayanyinterestoncurrentaccountbut
chargesinterestonloans.

(ii)Bondanddebentureholders:

Inaneconomy,therearesomepeoplewholive
oninterestincometheysuffermost.
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Bondholdersearnfixedinterestincome:These
peoplesufferareductioninrealincomewhen
pricesrise.Inotherwords,thevalueofones
savingsdeclineiftheinterestratefallsshortof
inflationrate.Similarly,beneficiariesfromlife
insuranceprogrammesarealsohitbadlyby
inflationsincerealvalueofsavingsdeteriorate.

(iii)Investors:

Peoplewhoputtheirmoneyinsharesduring
inflationareexpectedtogainsincethe
possibilityofearningofbusinessprofit
brightens.Higherprofitinducesownersoffirm
todistributeprofitamonginvestorsor
shareholders.

(iv)Salariedpeopleandwageearners:

Anyoneearningafixedincomeisdamagedby
inflation.Sometimes,unionisedworkersuc
ceedsinraisingwageratesofwhitecollar
workersasacompensationagainstpricerise.
Butwageratechangeswithalongtimelag.In
otherwords,wagerateincreasesalwayslag
behindpriceincreases.Naturally,inflation
resultsinareductioninrealpurchasingpower
offixedincomeearners.

Ontheotherhand,peopleearningflexible
incomesmaygainduringinflation.Thenominal
incomesofsuchpeopleoutstripthegeneral
pricerise.Asaresult,realincomesofthis
incomegroupincrease.

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(v)Profitearners,speculatorsandblack
marketers:

Itisarguedthatprofitearnersgainfrom
inflation.Profittendstoriseduringinflation.
Seeinginflation,businessmenraisethepricesof
theirproducts.Thisresultsinabiggerprofit.
Profitmargin,however,maynotbehighwhen
therateofinflationclimbstoahighlevel.

However,speculatorsdealinginbusinessin
essentialcommoditiesusuallystandtogainby
inflation.Blackmarketersarealsobenefitedby
inflation.

Thus,thereoccursaredistributionofincome
andwealth.Itissaidthatrichbecomesricher
andpoorbecomespoorerduringinflation.
However,nosuchhardandfastgeneralisation
canbemade.Itisclearthatsomeonewinsand
someonelosesduringinflation.

Theseeffectsofinflationmaypersistifinflation
isunanticipated.However,theredistributive
burdensofinflationonincomeandwealthare
mostlikelytobeminimalifinflationis
anticipatedbythepeople.Withanticipated
inflation,peoplecanbuilduptheirstrategiesto
copewithinflation.

Iftheannualrateofinflationinaneconomyis
anticipatedcorrectlypeoplewilltrytoprotect
themagainstlossesresultingfrominflation.
Workerswilldemand10p.c.wageincreaseif
inflationisexpectedtoriseby10p.c.

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Similarly,apercentageofinflationpremium
willbedemandedbycreditorsfromdebtors.
Businessfirmswillalsofixpricesoftheir
productsinaccordancewiththeanticipated
pricerise.Nowiftheentiresocietylearntolive
withinflation,theredistributiveeffectof
inflationwillbeminimal.

However,itisdifficulttoanticipateproperly
everyepisodeofinflation.Further,evenifitis
anticipateditcannotbeperfect.Inaddition,
adjustmentwiththenewexpectedinflationary
conditionsmaynotbepossibleforallcategories
ofpeople.Thus,adverseredistributiveeffects
arelikelytooccur.

Finally,anticipatedinflationmayalsobecostly
tothesociety.Ifpeoplesexpectationregarding
futurepricerisebecomestrongertheywillhold
lessliquidmoney.Mereholdingofcash
balancesduringinflationisunwisesinceitsreal
valuedeclines.Thatiswhypeopleusetheir
moneybalancesinbuyingrealestate,gold,
jewellery,etc.Suchinvestmentisreferredtoas
unproductiveinvestment.Thus,duringinflation
ofanticipatedvariety,thereoccursadiversion
ofresourcesfromprioritytononpriorityor
unproductivesectors.

(b)EffectonProductionandEconomic
Growth:

Inflationmayormaynotresultinhigher
output.Belowthefullemploymentstage,
inflationhasafavourableeffectonproduction.
Ingeneral,profitisarisingfunctionoftheprice
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level.Aninflationarysituationgivesanincen
tivetobusinessmentoraisepricesoftheirprod
uctssoastoearnhighervolumeofprofit.Rising
priceandrisingprofitencouragefirmstomake
largerinvestments.

Asaresult,themultipliereffectofinvestment
willcomeintooperationresultinginahigher
nationaloutput.However,suchafavourable
effectofinflationwillbetemporaryifwagesand
productioncostsriseveryrapidly.

Further,inflationarysituationmaybeas
sociatedwiththefallinoutput,particularlyif
inflationisofthecostpushvariety.Thus,there
isnostrictrelationshipbetweenpricesand
output.Anincreaseinaggregatedemandwill
increasebothpricesandoutput,butasupply
shockwillraisepricesandloweroutput.

Inflationmayalsolowerdownfurtherpro
ductionlevels.Itiscommonlyassumedthatif
inflationarytendenciesnurturedbyexperienced
inflationpersistinfuture,peoplewillnowsave
lessandconsumemore.Risingsaving
propensitieswillresultinlowerfurtheroutputs.

Onemayalsoarguethatinflationcreatesanair
ofuncertaintyinthemindsofbusiness
community,particularlywhentherateofin
flationfluctuates.Inthemidstofrisinginfla
tionarytrend,firmscannotaccuratelyestimate
theircostsandrevenues.Thatis,inasituation
ofunanticipatedinflation,agreatdealofrisk
elementexists.

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Itisbecauseofuncertaintyofexpected
inflation,investorsbecomereluctanttoinvestin
theirbusinessandtomakelongterm
commitments.Underthecircumstance,
businessfirmsmaybedeterredininvesting.
Thiswilladverselyaffectthegrowth
performanceoftheeconomy.

However,slightdoseofinflationisnecessaryfor
economicgrowth.Mildinflationhasan
encouragingeffectonnationaloutput.Butitis
difficulttomakethepriceriseofacreeping
variety.Highrateofinflationactsasadis
incentivetolongruneconomicgrowth.Theway
thehyperinflationaffectseconomicgrowthis
summeduphere.Weknowthathyperinflation
discouragessavings.

Afallinsavingsmeansalowerrateofcapital
formation.Alowrateofcapitalformation
hinderseconomicgrowth.Further,during
excessivepricerise,thereoccursanincreasein
unproductiveinvestmentinrealestate,gold,
jewellery,etc.Aboveall,speculativebusinesses
flourishduringinflationresultinginartificial
scarcitiesand,hence,furtherriseinprices.

Again,followinghyperinflation,exportearnings
declineresultinginawideimbalancesinthe
balanceofpaymentaccount.Oftengalloping
inflationresultsinaflightofcapitaltoforeign
countriessincepeopleloseconfidenceandfaith
overthemonetaryarrangementsofthecountry,
therebyresultinginascarcityofresources.
Finally,realvalueoftaxrevenuealsodeclines
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undertheimpactofhyperinflation.Government
thenexperiencesashortfallininvestible
resources.

Thuseconomistsandpolicymakersare
unanimousregardingthedangersofhighprice
rise.Buttheconsequenceofhyperinflationare
disastrous.Inthepast,someoftheworld
economies(e.g.,GermanyaftertheFirstWorld
War(19141918),LatinAmericancountriesin
the1980s)hadbeengreatlyravagedby
hyperinflation.

TheGermaninflationof1920swasalso
catastrophic:

During1922,theGermanpricelevelwentup
5,470percent.In1923,thesituationworsened
theGermanpricelevelrose1,300,000,000(1.3
billion)times.ByOctoberof1923,thepostage
inthelightestlettersentfromGermanytothe
UnitedStateswas200,000marks.Buttercost
1.5millionmarksperpound,meat2million
marks,aloafofbread200,000marks,andan
egg60,000marks!Pricesincreasedsorapidly
thatwaiterschangedthepricesonthemenu
severaltimesduringthecourseofalunch!!
Sometimes,customershadtopaythedouble
pricelistedonthemenuwhentheyobservedit
first!!!Aphotographoftheperiodshowsa
Germanhousewifestartingthefireinher
kitchenstovewithpapermoneyandchildren
playingwithbundlesofpapermoneytied
togetherintobuildingblocks!

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Currently(September2008),Indianeconomy
experiencedaninflationrateofalmost13p.c.
anunprecedentedoneoverthelast16or17
years.However,analltimerecordinpricerise
inIndiawasstruckin197475whenitrose
morethan25p.c.Anyway,peopleareultimately
harassedbythehighdoseofinflation.Thatis
why,itissaidthatinflationisourpublicenemy
numberone.Risinginflationrateisasignof
failureonthepartofthegovernment.
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