B. On the Basis of Speed or Intensity:

(i) Creeping or Mild Inflation:

If the speed of upward thrust in prices is slow but small then we have creeping inflation. What speed of annual price rise is a creeping one has not been stated by the economists. To some, a creeping or mild inflation is one when annual price rise varies between 2 p.c. and 3 p.c. If a rate of price rise is kept at this level, it is con­sidered to be helpful for economic development. Others argue that if annual price rise goes slightly beyond 3 p.c. mark, still then it is considered to be of no danger.

(ii) Walking Inflation:

If the rate of annual price increase lies between 3 p.c. and 4 p.c., then we have a situation of walking inflation. When mild inflation is allowed to fan out, walking inflation appears. These two types of inflation may be described as ‘moderate inflation’.

Often, one-digit inflation rate is called ‘moder­ate inflation’ which is not only predict­able, but also keep people’s faith on the monetary system of the country. Peoples’ confidence get lost once moderately maintained rate of inflation goes out of control and the economy is then caught with the galloping inflation.

(iii) Galloping and Hyperinflation:

Walking inflation may be converted into running inflation. Running inflation is danger­ous. If it is not controlled, it may ulti­mately be converted to galloping or hyperinflation. It is an extreme form of inflation when an economy gets shatter­ed.”Inflation in the double or triple digit range of 20,100 or 200 p.c. a year is labelled “galloping inflation”.

(iv) Government’s Reaction to Inflation:

In­flationary situation may be open or suppressed. Because of anti-infla­tionary policies pursued by the govern­ment, inflation may not be an embar­rassing one. For instance, increase in income leads to an increase in con­sumption spending which pulls the price level up.

If the consumption spending is countered by the govern­ment via price control and rationing device, the inflationary situation may be called a suppressed one. Once the government curbs are lifted, the sup­pressed inflation becomes open infla­tion. Open inflation may then result in hyperinflation.

CAUSES OF INFLATION

The causes underlying inflation can be generally divided according to the source through which inflation originates. As we learnt in price of a commodity is determined at the point at which its supply equals demand. This is known as the equilibrium price. If the demand goes up, price of the commodity would go up in order to restore the equilibrium. So is the case when there is a fall in supply of a commodity. In either case the price of the commodity goes up till the supply and demand are equalized. But the source of the change in one case originates from the supply side while in the other from the demand side. Sometimes, rise in the cost of production pushes up the supply schedule.

This again leads to a rise in prices. So, depending upon initial process, we can identify two types of inflation:

Demand pull inflation or, demand-side inflation; and Cost-push inflation or, cost-side inflation. Note that here, we refer to aggregate demand and aggregate supply in the economy.

Inflation: The Demand-Side

Factors, which influence an increase in aggregate demand with no change in the level of aggregate supply, can be said to cause demand-side inflation. These factors can be an increase in government spending, a decrease in savings rate and a lower rate of taxation, which leave greater amount of money or, increased disposable income with the public, and increase in money supply. Let us examine, how each of these factors generates inflationary tendencies. I) Inflation Caused by Increase in Government Spending Suppose the government decides to build roads. In the process many unemployed get employment and earn an income. This increases the number of people who have money to spend. With no change in aggregate supply in the economy, a situation of excess demand arises.

There are two ways in which this excess demand can be met, viz., by increasing the production and supply of commodities or, by increasing the price level, which would then have negative impact on the demand. In the short run, more often than not, it is difficult to expand supply. Hence the price level increases to equilibrate the aggregate supply and aggregate demand. An increase in demand arising out of the increased government spending could be depicted by a shift in the aggregate demand (AD) curve as shown in Fig. 19.1. In the figure the aggregate supply (AS) curve is shown as a vertical line implying that we have taken aggregate supply as fixed in the short run. Thus with unchanged supply, the national real income remains at Y and only the price level goes up to equilibrate demand and supply.

Keynesian Inflationary Gap

Keynesian Inflationary Gap A related, but a slightly different type, is the Keynesian inflationary gap. Recall that in Keynesian theory, investment plays the vital role in determining the national income. In the Keynesian system, the economy is divided into three broad sectors, namely, the household sector, the government sector and the private sector. The households earn money by offering their labour and other factor services and consume a part of it and save the rest. The private sector produces goods and services, earns profits and invests a part of that, say, for buying machines. The government sector gets revenue from these two sectors by way of taxes and spends it on building of roads, public services and so on. The total income of the economy or the national income consists of the goods and services produced by the above sectors. Expenditure, on the other hand, is the aggregate of consumption, C, investment, I, and government spending, G. Equilibrium in the Keynesian system is obtained where the income, Y, earned in the economy equals the expenditure on it. Assuming that there is no government spending, expenditure would then constitute consumption, C, by households, plus investment, I, by firms.

 Diagrammatically, equilibrium is obtained where the expenditure line, C+I+G, intersects the 450 -degree line (depicting income = expenditure), as shown in Fig. 19.2. If government expenditure is raised, the point at which the expenditure line C+I+G’ intersects the 450 degree line depicts an increase in the national income level. However, suppose for various reasons, the income level cannot be increased. Then we have a situation of excess demand equal to MN, which will be purely inflationary. MN is known as the inflationary gap.

Inflation due to Increase in Money Supply The above argument holds when there is an increase in the money supply. With increased money supply, there is more money to spend at the disposal of general public. Again a situation of excess demand arises, i.e., a situation of disequilibrium and general price level goes up to restore equilibrium in the system. In this case there is no change in the aggregate supply curve as depicted in Fig. 19.1..

Causes of Demand-Pull Inflation:

DPI originates in the monetary sector. Mon­etarists’ argument that “only money matters” is based on the assumption that at or near full employment excessive money supply will in­crease aggregate demand and will, thus, cause inflation. An increase in nominal money supply shifts aggregate demand curve rightward. This enables people to hold excess cash bal­ances. Spending of excess cash balances by them causes price level to rise. Price level will continue to rise until aggregate demand equals aggregate supply. Keynesians argue that inflation originates in the non-monetary sector or the real sector. Aggregate demand may rise if there is an increase in consumption expenditure following a tax cut. There may be an autonomous increase in business investment or government expendi­ture. Government expenditure is inflationary if the needed money is procured by the gov­ernment by printing additional money.

             In brief, increase in aggregate demand i.e., in­crease in (C + I + G + X – M) causes price level to rise. However, aggregate demand may rise following an increase in money supply gen­erated by the printing of additional money (classical argument) which drives prices up­ward. Thus, money plays a vital role. That is why Milton Friedman argues that inflation is always and everywhere a monetary phenom­enon. There are other reasons that may push ag­gregate demand and, hence, price level up­wards. For instance, growth of population stimulates aggregate demand. Higher export earnings increase the purchasing power of the exporting countries. Additional purchasing power means additional aggregate demand. Purchasing power and, hence, aggregate de­mand may also go up if government repays public debt.

Again, there is a tendency on the part of the holders of black money to spend more on conspicuous consumption goods. Such tendency fuels inflationary fire. Thus, DPI is caused by a variety of factors.

Inflation: The Supply-Side

Inflation arising out of movements in the aggregate supply curve with the aggregate demand curve remaining unchanged is known as supply-side inflation. Cost-push inflation, profit-push inflation and supply-shock inflation are three variants of this idea. I)

Cost-push Inflation

Cost-push inflation arises when either the labour unions (or the firms) exercise their market power to increase the wage rate (or the price of their products),. With an increase in the wage rate, producers find that the labour cost per unit of output have risen, and they respond by increasing the prices of goods to cover the higher cost of production. The workers, faced with higher prices, demand still higher wage rate, to which the producers respond by increasing the price of their commodities. A series of increase, in wage rates leads to a series of increase in price. This kind of inflation is known as wage-push inflation. When the firms increase the price of their products to increase their profits, there is a demand for higher wage rate by the workers.

Higher cost of production due to increases in the wage rate and prices of inputs makes the producers raise their prices further. Again a series of increase in the wage rate leads to a series of increase in the prices. This kind of inflation is known as profit-push inflation.In both the cases, each possible level of output will be supplied at a higher price level than before. As shown in Fig. 19.3, the aggregate supply curve (in this case we have taken a curved supply curve for analytical convenience) moves inwards showing that for the same level of output Y1 the price now being charged is P2 , which is higher than P1 .

Note, in this case, unlike in demand pull type of inflation, the output level goes down from Y1 to Y2 . A pre-requisite for inflation due to increases in the wage rate is that of unionisation of labour. In India labour is not organized in all sectors and there is very little empirical evidence showing inflation arising out of increases in the wage rate. Similarly a pre-requisite for the firms to increase the prices is that the firms must be operating in an imperfect market. A firm, which has many competitors, would be unable to increase the price of its products because of the fear of losing its customers. On the other hand, fear of monopolistic or oligopolistic firms can increase their prices without the fear of losing out on demand.

Supply-shock Inflation Inflation can arise out of either an unexpected or unforeseen sharp fall in the supply of commodities or a rise in the prices of commodities. Reasons for a situation lie out of the control of either the firms or the workers. It is known as supply-shock inflation. For instance, a crop failure due to an unfavourable weather condition would give rise to an all round shortage and lead to increase in the general price level. The above can be an example of the supply-shock inflation. Similarly, in 1973 and 1979, when oil prices were unexpectedly raised by the OPEC all the economies world wide experienced a massive rise in the general prices.This is another manifestation of supply-shock inflation.

Causes of Cost-Push Inflation:

It is the cost factors that pull the prices up­ward. One of the important causes of price rise is the rise in price of raw materials. For in­stance, by an administrative order the govern­ment may hike the price of petrol or diesel or freight rate. Firms buy these inputs now at a higher price. This leads to an upward pres­sure on cost of production. Not only this, CPI is often imported from outside the economy. Increase in the price of petrol by OPEC com­pels the government to increase the price of petrol and diesel. These two important raw materials are needed by every sector, espe­cially the transport sector. As a result, trans­port costs go up resulting in higher general price level.

Again, CPI may be induced by wage-push inflation or profit-push inflation. Trade unions demand higher money wages as a compen­sation against inflationary price rise. If in­crease in money wages exceed labour produc­tivity, aggregate supply will shift upward and leftward. Firms often exercise power by push­ing prices up independently of consumer de­mand to expand their profit margins. Fiscal policy changes, such as increase in tax rates also leads to an upward pressure in cost of production. For instance, an overall in­crease in excise tax of mass consumption goods is definitely inflationary. That is why govern­ment is then accused of causing inflation.

Finally, production setbacks may result in decreases in output. Natural disaster, gradual exhaustion of natural resources, work stop­pages, electric power cuts, etc., may cause ag­gregate output to decline. In the midst of this output reduction, artificial scarcity of any goods created by traders and hoarders just simply ignite the situation. Inefficiency, corruption, mismanagement of the economy may also be the other reasons. Thus, inflation is caused by the interplay of various factors. A particular factor cannot be held responsible for any inflationary price rise.

STRUCTURAL INFLATION

Theories of inflation discussed so far have all been developed with particular reference to the developed countries. In most cases, they do not have the same applicability to inflationary experience of developing countries like India. Unlike developed countries of the West, the developing countries are characterized by a lack of adequate resources like capital, foreign exchange (for essential imports like machinery and technology), land and infrastructure (roads, railways, power etc.). Further, over-population with the majority depending on agriculture for their livelihood means that there is a fragmentation of the land holdings. There are other institutional factors like land-ownership, technological backwardness and low rate of investment in agriculture. These features are typical of the developing economies. ‘Structural theory of inflation’ explains inflation in the developing economies in terms of the structural features.  

Food Shortages

Majority of population in the developing economies live in the rural areas and depend on agriculture for their livelihood. With development, say, building of some new industry, some people get employment outside of agriculture and they settle down in urban areas. But, due to the various structural features such as highly unequal distribution of land-ownership and tenancy, technological backwardness and low rates of investment in agriculture, inadequate growth of the domestic supply of food in correspondence with an increase in demand arising from increasing urbanization and population prices increase. Further, the extreme dependence of agriculture on weather produces an acute shortage of food from time to time due to droughts, floods, etc. In years of food shortages, the prices of food grains increases very fast. Food being the key wage-good, an increase in its price tends to raise other prices as well. Therefore, some economists consider food prices to be the major factor, which leads to inflation in the developing economies. II)

Scarcity of Foreign Exchange

The industrial development of the developing economies requires a heavy import bill on account of import of capital goods, essential raw materials, and in several cases even food grains and other consumer goods. While the developing economies have a very high import requirement, their exports to the developed economies are very small for reasons like poor quality of goods. As a result, the foreign exchange that comes into the country through exports is a much smaller amount than the requirements of the economy. Due to this, the developing economies most of the times face foreign exchange shortages. Moreover, the shortages in the domestic supply of many basic inputs cannot easily be mitigated through imports. As a result, the prices of such goods increase, and the increase spreads to other prices. The result is all-round inflation. Other structural factors, like socially unproductive private investment in land and precious metals like gold take away a sizable chunk of resources. These resources could have been otherwise invested in new industries, new machines, new roads, better irrigation facilities for agriculture and other productive investment, which could have led to faster development of these countries. According to the structural approach to inflation, the above factors and similar other structural features of the developing economies can explain the price rise situations better.

PRICE TRENDS IN INDIA

Each plan documents in India has sought to ensure that there is no accentuation of * inflationary pressures in thc course of the plan and that the levels of living of the morc vulnerable classes in society are safe guarded. However, even as overall price stability has becn an avowcd objective of economic planning, the goal has eluded us almost persistently, as would be clear from a review below:

the whole period 1951-99 can conveniently be broken into three phases, viz.,

(i) 195 1-66, (ii) 1966-1990. and (iii) 1990 onwards.  

(i) Phase of 1951-66

Inflation. although moderate had its beginning in India with the onset of the heavy invcstmci~t programme during the mid-fifties. Thc WPI, which had gone down by about 22 per cent during the First Plan, went up by about 30 per cent during the five years of the Second Plan. The WPI went up by another 35 per cent during the Third Plan period. The rising trend of the WPI during this period could be attributed both to inflationary financing of the developmental programmes and shortfall in output, specially of agricultud products. Diversion of resources from development to defence in wake of external aggressions in sixties also contributed to the build-up of the inflationary pressures.

(ii) Phase of 1966-90

During this period, price variations cut across the plan periods and had shown considerable volatility. In all, seven sub-phases of price movements can be observed during the period 1966-90. High rates of inflation were witnessed during the years 1966-67 (1 3.9 per cent, ) and 1967-68 (1 1.6 per cent ) followed by four years of declining or gently rising price levels up to 1971-72. A sudden spurt in the general price level was noticed in 1972-73 to 1974-75 (25.2 per cent ). This was. followed by a distinct phase of four years (1975-76 to 1978-79) experiencing relative price st'ability. In 1979-80, again prices shot up by 17.1 per cent and then by 18.2 per cent in 1980-8 1. The rate of increase though still high, decelerated to 9.3 per cent in 1981.82. Thereafter. for the years, from 1982-83 to 1986-87, price increases were moderate, The foregoing review brings out on interesting aspect of the liatilre of inflation in India. The periods of high inflation are soon followed by periods of relative price stability. This deems to be the logical consequence of India's econom' ~c structure and fairly sensitive policy responses by the authorities to specific disturbances which give rise to macro economic and sectoral imbalances. 

(iii) Phase of 1990 onwards

Inflation has shown a dogged persistence in tlie post reforms period. In 1990-9 1, the year of macro economic chaos, there was a 12.1 per cent rise in the WPI. In the following fiscal year, there was a two -step devaluation of the rupee, which stipulated expectations; WPI went up by 13.6 per cent during the year 1991-92 . In 1992- 93 where there was a 6.9 per cent rise in foodgrains output and a 3.9 per cent rise in overall agricultural production, the inflation rate did come down to 7 per cent. During the two subsequent years, the inflation rate averaged 10.6 per cent.

As mentioned above the WPI has three parts- primary articles (weightage of 32.29 per cent ), fuel group (weightage of 10.66 per cent) and manufactured articles (weightage of 57.04 per cent). Primary articles - meaning unprocessed crops of food items and fibres plus livestock - are vulnerable to the vagaries of nature. The fuel group comprises mineral oils, electricity and coal. Inflation in this segment always tends to be high. In fact, in six of the last 10 years, inflation rate in the fuel group has averaged more than 10 per cent. However, over the last two years it has dropped. In '98-99, inflation rate averaged 4.3 per cent and in '99-00, it hovered at 8 per cent.

The largest contributor to the low inflation rate, as measured by the WPI, has been the 'manufactured products' group, where prices rose just 0.4 per cent, during 1999-2000 compared to 4.6 per cent in '98-99. This represents a dramatic drop in inflation rate. Manufactured products are also the area that is most significant among the three aomponents of inflation. There are two reasons for this - the high weightage and the fact that this group is vulnerable to structural changes in the economy. That is, the graup is more influenced by policy than the primary articles group. What is driving law inflation in the manufactured product items? As such. drawing generalised conclusions is hazardous. If inflation rate in this group is low it's because of certain definitive factors - low input prices, producers' effort to boost demand or even competitive pressures. The last factor is the most important because it has long term implications about the behaviiour of inflation. Evidence suggests that competitive pressures. both internal and external, could have played an important role in keeping manufacturing inflation low. If so, manufacturing inflation is not likely to rise in a hurry in the near future.

Overall, the Indian manufacturing sector is under more competitive pressures, both domestic and external. Categories contributing about 35 per cent of tlie WPI could be exposed to international competition. And, if one includes donlestic conlpetition in sectors like cement, consumer durables and automobiles too, the pricing power of a substantial part of the manufacturing basket could be affected by competitive pressures. Which direction will inflation take in the future? It is not possible to make an accurate forecast for the primary goods category because this section is unpredictable. In four of the last 10 years, inflation in this category exceeded 10 per cent and only in the last two years has it stabilised at less than 5 per cent.

Prices in the fuels category tend to rise religiously, and so inflation could hover at 8-10 per cent. That leaves the manufacturing sector, the big bogey. A large part of this section is now aligned with global cycles. Therefore, while demand revival should create conditions for manufacturing inflation to rise, it is likely that it may remain at 4-5 per cent levels in 2000-2001, where it has been for the last four years. Overall, therefore, the WPI should stay at 5-6 per cent for the next year. This will be a low for India.

The mid-nineties have witnessed a slowing down the rate of inflation. Although, the WPI has continued to move upwards, the rate of increase has been moderate, 7.7 per cent in 1995-96, 6.4 per cent in 1996-97, 4.8 per cent in 1997-98 and 6.9 per cent in 1998-99. 

It would be seen from the above review that India entered the age of rising prices in the mid-fifties. The price level has since been continuously rising. What has differed, however, is the rate at which prices have gone up at different stages. While during the fifties and the sixties, inflation used to be moderate and phases of stable prices intermingled with those of rising prices. The rate of inflation picked up fast during the mid-seventies, and accelerated further during the eighties and the first half of the nineties. The price line has been little smoother in the second half of the nineties. 

Effects of Inflation:

People’s desires are inconsistent. When they act as buyers they want prices of goods and services to remain stable but as sellers they expect the prices of goods and services should go up. Such a happy outcome may arise for some individuals; “but, when this happens, others will be getting the worst of both worlds.” When price level goes up, there is both a gainer and a loser. To evaluate the conse­quence of inflation, one must identify the na­ture of inflation which may be anticipated and unanticipated. If inflation is anticipated, peo­ple can adjust with the new situation and costs of inflation to the society will be smaller. In reality, people cannot predict accurately fu­ture events or people often make mistakes in predicting the course of inflation. In other words, inflation may be unanticipated when people fail to adjust completely. This creates various problems.

One can study the effects of unanticipated inflation under two broad head­ings:

(a) Effect on distribution of income and wealth; and

(b) Effect on economic growth.

(a) Effects of Inflation on Distribution of Income and Wealth:

During inflation, usu­ally people experience rise in incomes. But some people gain during inflation at the ex­pense of others. Some individuals gain be­cause their money incomes rise more rapidly than the prices and some lose because prices rise more rapidly than their incomes during inflation. Thus, it redistributes income and wealth.

Though no conclusive evidence can be cited, it can be asserted that following catego­ries of people are affected by inflation differ­ently:

(i) Creditors and debtors:

Borrowers gain and lenders lose during inflation because debts are fixed in rupee terms. When debts are repaid their real value declines by the price level increase and, hence, creditors lose. An individual may be interested in buying a house by taking loan of Rs. 7 lakh from an in­stitution for 7 years.

The borrower now wel­comes inflation since he will have to pay less in real terms than when it was borrowed. Lender, in the process, loses since the rate of interest payable remains unaltered as per agree­ment. Because of inflation, the borrower is given ‘dear’ rupees, but pays back ‘cheap’ ru­pees. However, if in an inflation-ridden economy creditors chronically loose, it is wise not to advance loans or to shut down business.

Never does it happen. Rather, the loan-giving institution makes adequate safeguard against the erosion of real value. Above all, banks do not pay any interest on current account but charges interest on loans.

(ii) Bond and debenture-holders:

In an economy, there are some people who live on interest income—they suffer most. Bondhold­ers earn fixed interest income: These people suffer a reduction in real income when prices rise. In other words, the value of one’s sav­ings decline if the interest rate falls short of inflation rate. Similarly, beneficiaries from life insurance programmes are also hit badly by inflation since real value of savings deterio­rate.

(iii) Investors:

People who put their money in shares during inflation are expected to gain since the possibility of earning of business profit brightens. Higher profit induces own­ers of firm to distribute profit among inves­tors or shareholders.

(iv) Salaried people and wage-earners:

Any­one earning a fixed income is damaged by in­flation. Sometimes, unionised worker suc­ceeds in raising wage rates of white-collar workers as a compensation against price rise. But wage rate changes with a long time lag. In other words, wage rate increases always lag behind price increases. Naturally, inflation results in a reduction in real purchasing power of fixed income-earners.

On the other hand, people earning flexible incomes may gain during inflation. The nominal incomes of such people outstrip the general price rise. As a re­sult, real incomes of this income group in­crease.

(v) Profit-earners, speculators and black marketers:

It is argued that profit-earners gain from inflation. Profit tends to rise during inflation. Seeing inflation, businessmen raise the prices of their products. This results in a bigger profit. Profit margin, however, may not be high when the rate of inflation climbs to a high level. However, speculators dealing in business in essential commodities usually stand to gain by inflation. Black marketers are also ben­efited by inflation. Thus, there occurs a redistribution of in­come and wealth. It is said that rich becomes richer and poor becomes poorer during infla­tion. However, no such hard and fast gener­alisation can be made. It is clear that someone wins and someone loses during inflation.

These effects of inflation may persist if in­flation is unanticipated. However, the redistributive burdens of inflation on income and wealth are most likely to be minimal if inflation is anticipated by the people. With anticipated inflation, people can build up their strategies to cope with inflation. If the annual rate of inflation in an economy is anticipated correctly people will try to protect them against losses resulting from inflation. Workers will demand 10 p.c. wage increase if inflation is expected to rise by 10 p.c.

Similarly, a percent­age of inflation premium will be demanded by creditors from debtors. Business firms will also fix prices of their products in accordance with the anticipated price rise. Now if the en­tire society “learn to live with inflation”, the redistributive effect of inflation will be mini­mal. However, it is difficult to anticipate prop­erly every episode of inflation. Further, even if it is anticipated it cannot be perfect. In addi­tion, adjustment with the new expected infla­tionary conditions may not be possible for all categories of people. Thus, adverse redistributive effects are likely to occur. Finally, anticipated inflation may also be costly to the society. If people’s expectation regarding future price rise become stronger they will hold less liquid money. Mere hold­ing of cash balances during inflation is unwise since its real value declines. That is why peo­ple use their money balances in buying real estate, gold, jewellery, etc. Such investment is referred to as unproductive investment. Thus, during inflation of anticipated variety, there occurs a diversion of resources from priority to non-priority or unproductive sectors.

(b) Effect on Production and Economic Growth:

Inflation may or may not result in higher output. Below the full employment stage, inflation has a favourable effect on production. In general, profit is a rising function of the price level. An inflationary situation gives an incen­tive to businessmen to raise prices of their prod­ucts so as to earn higher volume of profit. Ris­ing price and rising profit encourage firms to make larger investments.

As a result, the multi­plier effect of investment will come into opera­tion resulting in a higher national output. How­ever, such a favourable effect of inflation will be temporary if wages and production costs rise very rapidly.

Further, inflationary situation may be as­sociated with the fall in output, particularly if inflation is of the cost-push variety. Thus, there is no strict relationship between prices and output. An increase in aggregate demand will increase both prices and output, but a supply shock will raise prices and lower output. Inflation may also lower down further pro­duction levels. It is commonly assumed that if inflationary tendencies nurtured by experi­enced inflation persist in future, people will now save less and consume more. Rising sav­ing propensities will result in lower further outputs. One may also argue that inflation creates an air of uncertainty in the minds of business community, particularly when the rate of in­flation fluctuates. In the midst of rising infla­tionary trend, firms cannot accurately estimate their costs and revenues. That is, in a situa­tion of unanticipated inflation, a great deal of risk element exists. It is because of uncertainty of expected inflation, investors become reluc­tant to invest in their business and to make long-term commitments. Under the circum­stance, business firms may be deterred in in­vesting. This will adversely affect the growth performance of the economy.

However, slight dose of inflation is neces­sary for economic growth. Mild inflation has an encouraging effect on national output. But it is difficult to make the price rise of a creep­ing variety. High rate of inflation acts as a dis­incentive to long run economic growth. The way the hyperinflation affects economic growth is summed up here. We know that hyper-inflation discourages savings. A fall in savings means a lower rate of capital forma­tion. A low rate of capital formation hinders economic growth. Further, during excessive price rise, there occurs an increase in unpro­ductive investment in real estate, gold, jewel­lery, etc. Above all, speculative businesses flourish during inflation resulting in artificial scarcities and, hence, further rise in prices. Again, following hyperinflation, export earn­ings decline resulting in a wide imbalances in the balance of payment account. Often gallop­ing inflation results in a ‘flight’ of capital to foreign countries since people lose confidence and faith over the monetary arrangements of the country, thereby resulting in a scarcity of resources. Finally, real value of tax revenue also declines under the impact of hyperinfla­tion. Government then experiences a shortfall in investible resources.

Thus economists and policymakers are unanimous regarding the dangers of high price rise. But the consequence of hyperinfla­tion are disastrous. In the past, some of the world economies (e.g., Germany after the First World War (1914-1918), Latin American coun­tries in the 1980s) had been greatly ravaged by hyperinflation.

ANTI-INFLATIONARY POLICIES or REMEDIES TO CONTROL INFLATION

Now we have a fairly good idea about the causes of inflation. Let us move on to the question of its remedies. What are the possible ways to control the inflation in an economy? But for recommending a cure, an analysis of the source of the problem, i.e., whether inflation is due to demand-pull factors or cost-push factors, is important. Why that is so, is what we show below.