What is inflation? Describe its root causes. Also explain how it can be controlled?
Inflation means generally rising money prices of goods and services. To understand what inflation is and is not, consider the above definition in detail:
Goods and services: This refers not to stocks or bonds of other financial assets, but to the tangible and intangible commodities economic agents produce and sell to one another. These are commodities to be consumed or held for future use; e.g. food, haircuts, shelter, houses, health care, schooling, cars, tractors, machine tools.
Money prices: This refers to amounts of money, dollars and cents in the United States, per commodity unit, e.g., per pound of butter, gallon of gasoline, haircut, bus trip, kilowatt hours, or diesel engine. In contrast, imagine the barter prices at which one commodity trades for another; e.g., 3 gallons of a gas for 1 hour of labour, two bus fares for 1 pound of butter, one haircut for 100 kilowatt hours. From the money prices for any two commodities can be calculated their implicit barter price, their relative price in economists’ absolute prices, i.e., money prices.
Rising: This does not mean “high”. By some measures, money prices in the Pakistan were twice as high at the end of 1990 as in 1980.
Generally: Inflation refers to pervasive, widespread increases of money prices. A rising price for a single commodity, even beef or oil, is not per se inflation, any more than declining prices of pocket calculators of digital time pieces represent deflation.
Money And Inflation
To understand inflation and deflation, it is necessary to review the role of money ■ economic life. An economy where goods and services are always bartered directly for ach other would be spared inflation or deflation. It would also be terribly inefficient, r-haps the village cobbler can trade shoes for the farmer’s eggs, and even promise shoes morrow for eggs today, but imagine the difficulties if steel plants had to pay their rkers in steel ingots, or else trade the ingots for eggs and shoes and other goods more : their employees’ taste. Without money, much time and effort would be spent seeking executing mutually advantageous trades, and much capital would be tied up in entories. To escape these inefficiencies the people of even private societies have need among themselves on a common trading commodity, viz money.
The money of a society serves as a commonly accepted medium of exchange and a _ unit of account and calculation, goods and services can be traded for money rather _n directly for other goods and services. The cobbler can sell shoes for money and use money later to by eggs, as well as leather, nails, and the services of an apprentice, steel plant can sell ingots for money and pay us employees in money, and the workers can find and buy what they individually want. Prices can be quoted and values calculated in units of money. Imagine the difficulty of keeping track of barter prices for possible pairs of commodities.
Causes of Inflation
The major causes of inflation may be grouped under two headings:
- Increase in Demand which may be due to:
- increase in money supply;
- increase in disposable incomes;
- increase in community’s aggregate spending on consumption and investment goods;
- excessive speculation and tendency to hoarding and profiteering on the part of producers and traders;
- increase in foreign demand and hence exports;
- increase in salaries, wages or dearness allowance; and
- increase in population.
Generally the most important cause of inflation is excessive public expenditure financed by deficit financing during war or on the implementation of plans for economic development. The newly created money increases government demand for goods and services and also the purchasing power of the people through increase in disposable income.
2. No corresponding increase in The output of goods and services which may he
- deficiency of capital equipment;
- scarcity of other complementary factors of production, e.g., skilled labour or technicians, essential raw materials or lack of dynamic entrepreneurs;
- increase in exports for earning the required foreign exchange;
- decrease in imports owing to war or restrictions on imports necessitated by an adverse balance of payments and efforts to rectify it;
- speculative hoarding by the producers, traders and middlemen in anticipation of a further rise in prices;
- drought, famine or any other natural calamity adversely affecting agricultural production; and
- prolonged industrial unrest resulting in reduction of industrial production
The demand-pull inflation is caused primarily by factors operation on the demandside resulting in excess of aggregate demand over the available supply of goods and services. The cost-push inflation, on the other hand, is caused by increase in salaries wages, the rising cost of machinery and capital equipment and of essential raw material Actually, all the above factors operate simultaneously to exert inflationary pressure and if continued sufficiently long, to create hyper-inflation.