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What is Inflation? Discuss various types of Inflation.

By :    March 12, 2020

INFLATION

Inflation is the rate at which the general level of prices for goods and services is rising and, consequently, the purchasing power of currency is falling.

As a result of inflation, the purchasing power of a unit of currency falls. For example, if the inflation rate is 10%, then 10 kg of wheat that costs ₹100 in a given year will cost ₹110 the next year. As more money is required to purchase goods and services, the implicit value of currency falls.

TYPES OF INFLATION

Inflation can be classified into the following types:

  • Hyperinflation:Hyperinflation is very high inflation. Economists generally use the term “hyperinflation” to describe episodes when the monthly inflation rate is greater than 50%. At a monthly rate of 50%, an item that cost ₹1 on January 1 would cost ₹130 on January 1 of the following year. During times of hyperinflation, the value of currency declines continuously to the extent that people lose faith in domestic currency. As a result, they either prefer international currency or large stock of commodities.
  • Hyperinflation is caused by extremely rapid growth in the supply of “paper” money. It occurs when the government of a nation regularly issues large quantities of money to pay for a large stream of expenditures.
  • Galloping inflation: When the inflation rate rises to 10% or greater in a year, it is called galloping inflation. Money loses value so fast that businesses and income of workers cannot keep up with the prices of goods and services.
  • Walking inflation: When the inflation rate rises to 3-10% in a year, it is called walking inflation. It has a harmful effect on the economy. People start to buy more than they need, just to avoid much higher prices in the future. This drives the demand even further, so that suppliers fail to match the demand. As a result, common goods and services are priced out of the reach of most people.
  • Creeping inflation: When the inflation rate is up to 3%, it is called creeping inflation. It is defined as the situation when the inflation of a nation increases gradually, but continuously, over time. Creeping inflation is considered good for the economy because it acts as an incentive for suppliers to enhance production and indicates continuous rise in demand in the economy.
  • Deflation: When the overall price level decreases so that the inflation rate becomes negative, it is called deflation. It is the opposite of the often-encountered inflation. A reduction in money supply or credit availability is the reason for deflation in most cases. Reduced investment spending by the government or individuals may also lead to this situation.

Deflation is different from disinflation as the latter implies decrease in the level of inflation, whereas deflation implies negative inflation.

When the prices fall, the margin of suppliers reduces. As a result, some suppliers reduce and even shut down the production. Moreover, falling price level is indicative of falling demand in the economy, which further indicates fall in the living standard of people.

Usually, deflation is associated with fall in output and employment.

On the other hand, disinflation does not lead to fall in output and inflation; it only means the return of prices to their normal level.

Stagflation:

Stagflation is just like its name says: when economic growth is stagnant, but price inflation is still there. It is an unusual situation. A sluggish economy usually reduces the demand, enough to keep prices from rising. As workers get laid off, they buy less. As a result, businesses lower the prices to attract whatever customers remain. Slow growth in a normal market economy prevents inflation.

Policies that cause stagflation also create hyperinflation. The government or central banks expand the money supply in order to generate higher demand in the economy. At the same time, supply constraints prevent companies from producing more.

Headline inflation:

In layman terms, headline inflation refers to the inflation as reported by newspaper headlines. At present, headline inflation is the inflation figure as reported through the consumer price index(CPI), which is released monthly by the Bureau of Labour Statistics.

Earlier, headline inflation was based on the wholesale price index (WPI). The change has been undertaken because earlier the Reserve Bank of India (RBI) used to target inflation based on WPI, but now RBI targets inflation based on CPI.

Core inflation:

It is an inflation measure that excludes transitory or temporary price volatility as in the case of some commodities such as food items, energy products, etc. It reflects the inflation trend in an economy.

If temporary price shocks are taken into account, they may affect the estimated overall inflation numbers in such a way that they are different from actual inflation. To eliminate this possibility, core inflation is calculated to gauge the actual inflation apart from the temporary shocks and volatility.

Difference between headline and core inflation

Headline inflation contains all items, including food and oil, whose prices are highly volatile. Core inflation does not contain volatile items. Thus, it gives a more real data, a clearer picture about the economy for the economists, while headline inflation is of more concern to the common people, who get much affected with, especially, the prices of food articles.

  • Asset inflation: Asset price inflation is an economic phenomenon denoting a rise in price of assets, as opposed to ordinary goods and services. Typical assets are financial instruments such as shares as well as real estate.
  • Wages inflation: Wage push inflation is a general increase in the cost of goods that is preceded by and results from an increase in wages. To maintain corporate profits after an increase in wages, employers must increase the prices they charge for the goods and services they provide.

 

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