Inflation

Inflation (meaning, types, causes, effects,

measures to control, Inflationary gap) Trade
cycle (meaning, types, characteristics,
phases, controls over trade cycle)

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 Concept:
 In the words of Friedman, “Inflation is always and
everywhere a monetary phenomenon…and can be
produced only by a more rapid increase in the
quantity of money than out­put.”

 But economists do not agree that money supply

alone is the cause of inflation.

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 Meaning:
 Coul born has beautifully define the term as “too
much money chasing too few goods”.

 According to the Crowther says, “Inflation is a

state of economy in which the value of money is
falling and prices are rising.

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 Types of Inflation

1. Creeping Inflation: When the rise in prices is very slow

like that of a snail or creeper, it is called creeping inflation. In terms
of speed, a sustained rise in prices of annual increase of less than
3 per cent per annum is characterized as creeping inflation

2. Walking or Trotting Inflation: When prices rise

moderately and the annual inflation rate is a single digit is walking
Inflation. In other words, the rate of rise in prices is in the
intermediate range of 3 to 6 per cent per annum or less than 10
per cent

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3. Running Inflation When prices rise rapidly like the
running of a horse at a rate or speed of 10 to 20 per cent
per annum, it is called running inflation

4. Hyperinflation: When prices rise very fast at double

or triple digit rates from more than 20 to 100 per cent per
annum or more, it is usually called runaway ox galloping
inflation
Such a situation brings a total collapse of mon­etary system
because of the continuous fall in the purchasing power of
money.

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 There are two kinds of inflation:
1. Demand pull inflation.
2. Cost push inflation.

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 Demand pull inflation: Demand-Pull or excess
demand inflation is a situation often described as “too much
money chas­ing too few goods.” According to this theory, an
excess of aggregate demand over aggregate supply will
generate inflationary rise in prices
i.e AD › AS = Inflation

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 Costs push inflation: When the firms pass on their
increased costs to consumers in the form of higher prices
inflation starts to rise. Important sources are higher wages,
increase in taxes.

 Cost-push inflation is caused by wage-push and profit-push to prices

for the following reasons:
1. Rise in Wages
2. Sectoral Rise in Prices
3. Rise in Prices of Imported Raw Materials
4. Profit-Push Inflation

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 Graphically,

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 Causes of inflation
 Population explosion: Due to increase more in population, the
increase in national output is insufficient to solve the problem of scarcity of
goods and hence, there is inflation.
 Political instability: Political instability discourages investment and
encourages speculation. Under such circumstances, the industrialist and
businessman feel unsecure and cannot make good plans for production.
 Imported inflation: A very important cause of inflation in Nepal is the
existence of inflation in their countries. The result in the Nepal has to import machinery,
raw material and other goods at higher prices.
 Nationalization: Due to nationalization of industrial in 1992, people were
discouraged to make investment in industrial. They become centers of in sufficient
production, high prices and poor quality goods were result.

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 Wages increases: The increase in wages of workers has also
contributed to inflation. Increase in wages result in higher cost of production
of goods. So their price rises.
 Climatic factors: Pakistan economies heavily depend upon
agriculture but due to weather condition many crops fall short of target, thus
pushing up prices. For example, Wheat production has also not kept pace
with rising demand.
 Oil crises: The oil prices in 1973 created by a large quantity of inflation
throughout the world. Import of oil is a high Burdon on our foreign exchange
resources. From time to time, oil exporting countries increase price of oil,
which raises transport cost.
 Artificial scarcity of goods: Frequent artificial scarcity of essential
items is created (cement, ghee, oil, sugar, etc) and huge profits are charged

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 Remedies of inflation:
 The main measures which are used to
control inflation are
1. Monitory policy.
2. Fiscal policy.
3. Direct measures and other
measures.

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 Monitory policy is a policy that influences the economy
through changes in money supply and available credit.
Monitory policy is adopted by central bank of country. The
various monitory measures which are used to control
inflation are grouped under heads.
a. Qualitative control.
b. Quantitative control.
There are:
1. Open market operations
2. Variation in bank rates
3. Credit rationing
4. Varying reserve requirements.
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 1. Quantitative Controls
 Quantitative controls affect the level of aggregate demand
through the supply of money, cost of money and availability
of credit. The quantitative methods include:
a. Bank rate policy
b. Open market operations and
c. Changes in reserve ratio

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 a. Bank rate policy: The bank rate is the minimum-lending rate of the
central bank at which it rediscounts first class bills of exchanges and
government securities hold by the commercial banks. At times of
inflationary pressures within the economy, central bank raises the bank
rate.
 b. Open market operations: It refers to the sale and purchase of
securities by the central bank. When prices are rising, the central bank
sells securities. The reserves of commercial banks are reduced and their
lending power is contracted.
 c. Changes in reserve ratio: Variable reserve ratio is a direct and
quick and effective method of controlling the power of the commercial
banks to create credit. Commercial banks are required by law to keep a
certain percentage of their deposits with the central bank in the form of
cash reserves

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