INFLATIONARY PRESSURES

A full theoretical analysis of the causes of inflation is difficult because there is no single theoretical
definition: there are varieties of inflation, each with a distinct theoretical explanation.
Inflationary pressures arise both from the demand side and the supply side. Demand means the demand of
money- income foe goods and supply means available output on which money – income can be spent. On
the demand side, the major factors which cause inflationary pressures are the supply of money, disposable
income, business expenditure and foreign demand. During war and past – war periods bank credit
expended to an enormous extent and became at once a cause and effect to inflationary pressure. Further,
during inflation, disposable income are likely to remain at high levels mostly on account of high levels of
national income. Similarly, expenditures on account of business opportunities also demand is also due to
foreign expenditures on domestic goods and services. A against, this type of sharp rise in the monetary
demand (demand for money), the supply of goods and services does increase but slowly, the basic
limiting factor being the level of full employment itself, resulting in shortage of labour, raw materials and
equipment, the supply position is further aggravated by the wage price spiral. According to Prof. K.K.
Kurihara, “these and many other dynamic influences coming as they do from both the demand side and
supply, lead to speculative business and consumer spending and add to the grow more rapidly than the
required rate of growth will suffer from inflation. Inflation may come about because the government
attempts to absorb more resources than are released by the private economy at the exiting price level. It
may come about because various groups in the economy attempt to improve their relative income shears
more rapidly than the growth of their productivity. It may come about because buoyant expectations
cause the demand for goods and services to rise more rapidly than it is possible for the economy to
expand output. And it may come about from interactions between some or all of the above factors” 2

THEORIES OF INFLATION
The theories are numerous, the subject is vast, the literature is voluminous: and definite conclusion are
few. The diversity of theories id due to the fact that there is no single theory capable or explaining all
inflations that have occurred in various countries throughout history. Since the end of the second World
War there has been a good deal of discussion regarding the causes of inflation. As a consequence of these
discussion, as well as extensive theoretical analysis and empirical for the phenomenon of inflation have
emerged. These may be the demand -pull inflation, the cost – push inflation, mixed demand inflation and
the structural inflation. Let us make an attempt to examine these theories of inflation.
THE DEMAND – PULL INFLATION
The theory of demand – pull inflation relates to what may be called the traditional theory of inflation. The
essence of this theory is that inflation is caused by an excess of this theory is that inflation is caused by an
excess of demand (spending) relative to the available supply of goods and service at existing prices.
According to classical, the key factor is the money supply because in accordance with the quantity theory
of money only an increase in the money supply is capable of raising the general price level. In modern
income theory, however, demand – pull is interpreted to mean an excess of aggregate money demand
relative to the economy’s full employment output level. The theory assumes that prices for goods and
services as well as for economic resources are responsive to supply and demand forces, and will thus,
move readily upward under the pressure of a high level, of aggregate demand Economic like Friedman,
Hawtrey, Golden Weiser, who regard inflation as a purely monetary phenomenon, strongly support this
theory of inflation caused by excess develops owing to large – scale investment expenditure either in the
public or in the privet sector, thereby exceeding the total output. As a result of this excess demand, prices
will rise and excess demand inflation or demand – pull inflation comes to exits. Thus, we find that
according to this theory of demand – pull inflation, prices rise response to an excess of aggregate demand
over existing supply of goods and services caused by an increase I the quantity of money – resulting in a
fall of interest rates – increasing investment expenditures and prices. But demand – pull inflation may
also be caused without an increase in money supply – when MEC or MPC goes up causing an increase is
due to excess demand, it is considered controllable by the reducing monetary and fiscal policies.
Excess demand approach is further developed by bent Hansen, Keynes, Wicksell and Sweedish
economists. Their view is that the general price is determined by the total demand for and total supply of
goods just as the price on any goods is determined by the forces of demand and supply for it. According
to them inflation is a situation caused by excess of supply of goods at prevailing prices. But a deeper
analysis will show that there is very little difference between the two approaches, that is the approach of
quantity theory supported by Million Friedman that excess demand is cause by excess money supply and
Bent Hansen – Keynes approach that excess demand is caused by increase expenditure on C and I,
especially when it is realised that excess demand can become effective only by means of an increase
supply of money.
The Figure 32.5 shows that pure – demand -inflation theorists tend to assume that at some income level
Y0 in the Figure corresponding to full employment, the aggregate supply function becomes completely
inelastic, as drawn. No income level lower than Y0is a fall employment one, and increase in demand
beyond D0, to D1 and D2 raise the price level from P0 to P1 and P2 Inflation is a dynamic

disequilibrium process. Implies a steady increase. In the price level over time, thus excess demand
inflation implies that the IS and /or the LM schedules continue to shift upward over time so that excess
demand for goods and services is perpetuated and general equilibrium is never established. Although an
increase in the price level would normally tend to clear markets, this does not take place if demand
continues to increase as fast as prices rise. Ultimately an excess demand inflation which is not fed by an
expanding money supply must come to an end. When interest rates rise to a high enough level, the
demand for money will become totally inelastic with respect to the rate of interest. At this point there are
no more speculative balances to be had, attempts to borrow funds either will be frustrated or, because of
the resultant increase in interest rates, will cause the abandonment of other ventures. When the demand
for money becomes inelastic, all funds are used for transaction purposes, and further increase in the
aggregate demand can then be financed only by a reduction in expenditure elsewhere in the economy or
by an increase in the transaction velocity of money. Thus, ultimately money supply is the causal factor.
Consider the diagram 32.6 which analysis the working of excess demand inflation irrespective of the fact
whether excess demand is caused by increased money supply or by increased expenditures on C and I.

Let us suppose that the full – employment level of output remains fixed at Y 0. General equilibrium is
established at Y0 and i0 with price level p0. An increase in the price level may now come about as a result
of an increase in aggregate demand, which shifts the IS 0 schedule to IS1; the resulting excess demand of Y1
- Y0 leads to a bidding up prices so that the real value of the money supply shrinks and the LM P0 schedule
shifts to LMP1, where general equilibrium is again established at the higher interest rate i 1 and higher price
level P1.
COST – PUSH INFLATION
The theory of cost – push inflation become popular during and after the Second World War. This theory
maintains that prices instead of being pulled- up by excess demand are also pushed- up as a result of a rise
in the cost of production. Under cost – push inflation prices rise on account of a rise in the cost of raw
materials, especially wages. The theory holds that the basic explanation for inflation is the fact that some
producers, group of workers or both, succeed in raising the price for either their product or services above
the levels that would prevail under more competitive conditions. In other words, inflationary pressures
originate with supply rather than demand and spread throughout the economy. Inflation of the cost – push
type originates in industries which are relatively concentrated and in which sellers can exercise price and
wages. Cost – push inflation may not be possible in an economy characterized by pure competition. Since
this inflation is due to the forces of cost and supply, It is not subject to easy treatment because fiscal and
monetary measure may cure a cost inflation only at the expense of increasing unemployment and slower
growth. That is why many cost – push inflation experts advocate mitigation rather than elimination of
inflation. The Figure32.7 illustrates the pure cost – push inflation phenomenon:
Figure 32.7 shows that according to pure supply (cost – push) inflation theorists - in societies of
oligopolies, unions and other pressure groups the aggregate supply curve moves upwards from S 0 to S1 to
S2 – whatever may happen to aggregate demand.

A usual characteristic of such markets is that the money wage rate is inflexible downward, the result of
which is an aggregate supply curve of the kind shown by S0S.with the initial S0S and D0 curves in the
Figure 32.7, we can turn to the process by which increase in the money wage rate push up the price level.
We assume that there is an increase in the money wage rate that result entirely from the exploitation of
the market strength of labour unions and in no part from increased productivity of labour or increased
demand for labour. Increase in wage rate has pushed S 0S curve to S1S. The price level at which each
possible level of output will be suppled increase proportionally with the increase in the money wage rate.
With aggregate demand of D0, the result of the higher money wage rate and the resultant upward shift in
SS function from S0S to S1S is a rise in the price level from P0 to P1 and a fall in the output level from Y0
to Y1’ (which results in unemployment). Thus, the rise in price level is accompanied by the appearance of
unemployment. Further increase in money wage will bring further upward shifts in the SS curves (e.g.,
S2S). Each increase in money wage rate leads to a higher price level, lower output and higher
unemployment. If left to
increase, such increase in the money wage rate cannot continue indefinitely as the money worsening
unemployment that follows each such increase may be expected to restrain the unions’ demand for ever
higher money wage rates.
Thus, this group of economists says that the process of inflation is caused not by an excess of demand but
by increase in cost, particularly when factors of production try to increase their shear of the total product
by raising their award of factor costs called cost – push inflation. It is cause by the monopoly elements
either in the labour market when there is wage – push or in the commodities market when there is profit –
push but mostly it is due to wage – push which increase the cost of production and hence prices. It has
been observed recently that in many countries labour unions have become very powerful so that they are
able to get wage increase almost every year greatly in excess of the overall average increase in output per
manhour. According to an important variant of the cost – push theory, sectoral shifts in demand are the
main causes of the inflationary process. For example, when the prices of tractors go up due to high price
of steel, the cost of agricultural products like food may go up necessitating a further rise in wages and so
on. Thus, cost – push inflation once set in motion in one industry or sector, spreads like wildfire in the
whole economy. The revival of cost – push inflation theory was staged by Willard Thorp and Richard
Quandt in their work ‘The new Inflation’ published in 1959. They emphasised the fact that cost – push
inflation is caused by wage increase due to strong tread union activities on the part of labour. The wage
increase and the rising cost of various inputs provide the initial impulse to inflation. It is due to rising cost
on account of wages that workers and employers try to increase try to include escalator clause in labour
contracts, agreeing to rise wage rates as soon as there is a rise in the cost-of-living index. Escalator
clauses provide for monetary correction on account of the facts of inflation, measure also known as
indexing. Under it as the inflation increase, the real income of labour is protected by equivalent wage
increase. This, in turn, gives rise to cost -push inflation, which can occur during recession, recovery or
shortages or simultaneously with demand – pull inflation. In some industries or in case of certain goods,
prices are determined less by demand and supply and more by administrative action, for example, when
management in some industries raise prices in an attempt to increase profits, it results in administrative
inflation. This has happened in steel, cement, coal, oil industries in the world and in India where there has
been 30 to 50 per cent increase in prices despite high unemployment of both men and machines.
However, both monetarists and Keynesians reject the idea of administrative type cost – push inflation – in
fact monetarists reject all versions of cost – push inflation. Are there no limits to the extent to which this
merry cost – push chase of wages after prices and prices after wages can be carried? Consider the
adjacent fig.32.8
In this figure general equilibrium prevails at Y 0, i0 and p0. A price increase instigated autonomously by
monopolistic business group or as a result of wage pressure raise the price level to P1 and thus shifts the
LMP0 schedule to LMP1. But at the new equilibrium between the IS and LM function the level of output is
below the full – employment level and, thus, there will be uncleared markets and pressure on wages and
price to return to their former level. It looks, then, as if a general wage – price increase will create a
situation in which all the higher priced output will not be bought, and this means that cost- push inflation
is not likely to be self – sustaining as is sometimes believed.
The rise in wages and costs leading to rise in prices (wage – price spiral) will come to an end. Thought
the theory of cost – push inflation does tell us that in order to reduce unemployment a slowly rising price
level is better than slowly sagging price level.
MIXED DEMAND INFLATION
The problem of identifying the basic nature and fundamental source of inflation continues. Does inflation
arise from the demand side of the goods, factor and asset markets or from the supply side or from some
combination of the two – the so – called mixed inflation. Many economists have come to believe that the
actual process of inflation is neither due to demand – pull alone, nor due to cost – push alone, but due to a
combination of both the elements of demand – pull and cost – push – called mixed inflation. The process
may be initiated either by demand – pull or by cost- push but it cannot be maintained unless other forces
also operate activity. The major difference between the two theories of the inflation process centers on the
responsiveness of both the money wages and prices to change in demand. Those who believe that there is
wage and price flexibility in the economy argue in favour of demand -pull inflation: because such
flexibility renders it impossible for any cost induces inflationary trend to sustain itself. On the other hand,
those who believe that wages and prices are not flexible emphasize the cost- push theory or inflation.
Neither approach taken by itself should be considered a completely satisfactory explanation of the cause
and nature of inflation – both the approaches are supplementary rather than competitive (or alternative) as
explanations of the cause of inflation. The adjacent Figure show cause of mixed inflation.
One variety of mixed – inflation theory (in Fig.32.9) denies for several reasons (one of them money
illusion), that aggregate supply is price- inelastic at full employment. In the Fig. 32.9(Y 0, P0), (Y1, P1) and
(Y2, P2) are all full employment position in that no involuntary unemployment exists. This first
corresponds to A.P. Lerner’s “low full employment” with substantial voluntary unemployment, and the
last to his “high full employment” with little or none. The region between low and high full employment
was called by Keynes “semi – inflation” in contrast to the true of full inflation. Mixed inflation theorists
usually think society prefers the couple (Y2, P2) to other alternatives, even when all three are full –
employment positions. In this type mixed inflation does not continue after (Y 2, P2) is reached. In this
respect, the solution related more closely to demand than to cost inflation.
COST – PUSH INFLATION: ITS RELATION TO DEMAND PULL OR MIXED INFLATION
Dichotomy in inflation theory; demand – pull and cost- push, is now a part of the language of economics,
some economists object to its implication that an inflation is either demand – pull or cost – push. They
argue that any actual inflationary process contains some elements of both. Expressed in the fashion their
argument can hardly be denied. However, if the dichotomy is accepted as nothing more than a convenient
two – fold classification of types of causation, their objections do not apply; it is at least helpful in
separating and interdependently at work in any actual inflationary process.
In terms of this dichotomy, it should be noted that there is a lack of symmetry between the demand - pull
and cost – push theories. An inflationary process may begin with generalized excess demand and may be
expected to persist as long as excess demand is present, even though no cost-push forces whatsoever are
at work. Excess demand will raise prices, which in turn will raise wage rates. But the rise in wage rates in
this case is not the result of cost – push We notice, however, that this does not rule out the possibility that
cost -push forces may also be at work to produce an even greater rise in wage rates. On the other hand, an
inflationary process may begin on the supply side but it will not long persist unless there is an increase in
demand. For example, an autonomous rise in wage rates will raise prices in the absence of any increase in
demand. For a cost- push inflation so initiated to be sustained however, one wage increase must be piled
on top of another; but in the absence of an increase in demand this would mean ever smaller production
and ever greater unemployment. Sooner or later, this must limit any inflationary process that depends on
charges on the supply side alone. This asymmetry can be illustrated by Fig.32.10.
With output at Yf shifts in the aggregate demand function from AD1 to AD2 to Ad3 and beyond can carry
the price level ever higher, from A to E to G, and so forth, in a sustained inflationary process. With full
employment, wage rates will rise along with prices as producers, encouraged to expand output by the
enlarged profit that result from the rising aggregate demand, increase their demand for labour. As long as
the forces feeding the demand for final output continues to shift the AD function ever higher, Inflation
will continue unchecked. In the extreme case, a run – away price level known as ‘hyper – inflation” may
result, however, starting again from Y1 a wage push or a profit push that shifts the aggregate supply
function from AS1 to AS2 will, with the AD function still at AD1, produce an intersection at B and reduce
output below the full employment level. A further upward push on the supply side to AS 3 unless
accompanied by a shift in AD above AD1 will move the intersection to ‘C’ and further reduce output and
employment. The successive reductions in output and the growing unemployment that result under these
conditions will bring the inflation to an end. Thus, unlike demand pull, inflation may originate on the
supply side but it cannot be sustained unless there is an appropriate increase on the demand side.
DEMAND – PULL VERSUS COST – PUSH INFLATION
No single explanation will suffice when we deal with a phenomenon a complicated as inflation in the
modern economy. Some economists object that inflation is either demand – pull or cost push and feel that
the actual inflationary process contains some element of both. These theories should not be taken as
alternative in any absolute sense but as approaches that lay stress on one factor relatively more than the
other. In practice, it is very difficult to establish by empirical teste whether inflation is demand – pull or
cost – push. Pure demand – pull or a pure cost – push inflation is rarely found. It is true that modern
economic analysis no longer sees the problem of inflation as basically a matter of too much money in
circulation, but this does not mean that money supply is not important. Barring unprecedented shifts in
the velocity of circulation of money (V), all the theories of inflation predicate increase in the money
supply. H. Johnson, therefore, remark, “The two theories are not independent and self – contained
theories of inflation, but rather theories concerning the mechanism of inflation in a monetary environment
that permits it.”1
Fritz Machlup in one of his recent papers2 has presented another view of cost – push and demand – pull
inflation. According to Machlup, inflation may be defined as a rising price level. Yet it needs
considerable expansion and clarification before it can really be considered meaningful. He deals with the
contention that the distinction between cost – push and demand – pull inflation is unworkable, irrelevant,
or even meaningless. There is group of outstanding economists who contend that there cannot be such a
thing as a cost – push inflation because, without an increase in the purchasing power and demand, cost
increase would lead to unemployment and depression, not to inflation. Similarly, there are assumptions
for which it would be appropriate to say that demand – pull is no cause inflation - it takes cost – push to
produce it. In other words, the contention must be granted that there are conditions under which ‘effective
demand’ is not effective and won’t pull up prices, and when it takes a cost - push to produce price
inflation. But this position ignores an important distinction, namely, whether the cost – puch is
‘equilibrating’ in the sense that is ‘absorbs’ a previously existing excess demand or whether it is
‘disequilibrating’ in the sense that it creates an excess supply (of labour and productive capacity) that will
have to be prevented or removed by an increase in effective demand. Fritz Machlup identifies the
limitations of the conventional approach to inflation and develops a more adequate framework in terms
of the concept of autonomous, induced, and supportive demand inflation and aggressive, defensive, and
responsive cost inflation. On the basis of the inflationary process and applied them briefly to what may be
the most perplexing problem in the study of inflation – indentifing whether any concrete or demand-pull
forces.
THE STRUCTURAL HYPOTHESIS
Apart from the controversy about the demand pull and cost – push theories of inflation in the USA, Prof.
Charles Schultze put forward an alternative theory of inflation called structural inflation hypothesis or
sectoral demand shift inflation theory. This theory was used to explain the American inflation of the
1950S. through1960s, 1970s, and the 1980s. It shows that inflation may be the consequence of internal
changes in the structure of demand, even though overall demand may not be excessive. This theory of
inflation is based on the fact that in many areas and sectors of the economy wages and prices are flexible
upward in response to increase in demand, but not flexible downward when demand declines. In other
words, this theory emphasizes the fact that inflation pressure can be generated by internal changes in the
composition of demand alone. In a dynamic economy such changes are an essential part of the economic
process, consequent upon changes in the structure of consumer tasted and desires. The expansion of
demand for the output of particular industries or sector will lead to wage and price increase in these areas
or sectors because wages and prices have an upward sensitivity when demand is rising. But the
contraction of demand in other sector will not lead to any corresponding downward movement of prices.
Thus, overall, the average level of prices will surely rise. The structural inflation thesis makes prices
inflation inherent in the process of resource allocation, if wages and price are flexible upward but not
demand – pull and cost – push inflations in that stresses changes in the composition of demand.
In this type analysis the starting point for inflation is a change in the structure and composition of
demand, which means a rise in demand for the products of particular industries – this is a common feature
in a dynamic economy. As a result, wages and prices rise upward in response to shifts in demand of
certain sectors but do not fall in those sectors where there is a relative decline in demand. Not only prices
and wages fail to fail in the industries where demand will force the demand deficient industries and
sectors to pay higher wages and price for labour and materials to continue their production. Thus, wage
price increases in particular areas gradually spread out and permeate the whole economy. The most
important implication of the structural explanation of inflation is that ordinary monetary and fiscal
measure of general character are not capable of coping with this type of inflationary situation. They may
control the aggregate demand which calls for different selective measure.
However, the position has been well summed up by James Tobin 1 - who says that the nature of current
global inflation specially of USA is complex, difficult to diagnose and unique in modern history. In
general, we may distinguish three types of inflation – (a) excess demand inflation – “ to much money
chasing too few goods” ; (b) the wage – price- wage spiral and (c) shortages and price increases, in
important ‘commodities’. To this may be added another variety of imported inflation : as a result of
unprecedented hike in oil prices by be the OPEC Cartal after 1973 affecting the domestic prices of
developed and developing economies prices of developed to Tobin our current inflation is a combination
of (b) and (c) above but monetarists ignore all types of distinctions and consider current inflation due to
(a) above.