INTRODUCTION

For a layman, inflation is just price rise. It becomes a matter of everyday discussion if the prices of daily or weekly items start rising. Whatever impact it might be having on other areas of economy, inflation might take an ugly turn and lead to a political crisis—at least in the developing economies. India has seen governments thrown out of power in elections due to price rise in daily-use items. This is not the case in the developed economies, but inflation takes its political toll there, too. In the developed economies, more aware and informed voters get carried away by the greater impact of higher or lower inflations in the elections. In this chapter, we will try to examine the concept of inflation from all possible dimensions to have an overall understanding.

DEFINITION

A rise in the general level of prices; a sustained rise in the general level of prices; persistent increases in the general level of prices; an increase in the general level of prices in an economy that is sustained over time; rising prices across the board —is inflation. These are some of the most common academic definitions of inflation. If the price of one good has gone up, it is not inflation; it is inflation only if the prices of most goods have gone up

Rate of inflation (year x) = Price level (year x) –Price level (year x-1)/Price level (year x-1) × 100

This rate shows up in percentage form (%), though inflation is also shown in numbers, i.e., digits. A price index is a weighted average of the prices of a number of goods and services

Causes of Inflation

1. Pre-1970s

Till the rise of the monetarist school, economists used to agree upon two reasons behind
inflation:

(i) Demand-Pull Inflation
A mis-match bet-ween demand and supply pulls up prices. Either the demand increases over the same level of supply, or the supply decreases with the same level of demand and thus the situation of demand-pull inflation arise. This was a Keynesian idea. The Keynesian School suggests cuts in spending as the way of tackling excess demand mainly by increasing taxes and reducing government expenditure. In practice, the governments keep tracking the demand-supply matrix to check such inflation. Depending upon the situation, the goods in short supply are imported, interest on loans increased and wages revised.

(ii) Cost-Push Inflation 
An increase in factor input costs (i.e., wages and raw materials) pushes up prices. The price rise which is the result of increase in the production cost is cost-push inflation. The Keynesian school suggested controls on prices and incomes as direct ways of checking such an inflation and, ‘moral suasions’ and measures to reduce the monopoly power of trade unions as indirect measures (basically, cost-push inflations chiefly used to happen due to higher wage demanded by the trade unions during the era).
Today, the governments of the world use many tools to check such inflations—reducing excise and custom duties on raw materials, wage revisions, etc.

2. Post-1970s

After the rise of Monetaristic School of Economics in the early 1970s (monetarism developed in opposition to post-1945 Keynesian idea of demand management), the school provided monetarist explanation for inflation, the so-called ‘demand-pull’ or the ‘cost-push’ which is excessive creation of money in the economy.

(i) Demand-Pull Inflation 
For the monetarists, a demand-pull inflation is creation of extra purchasing power to the consumer over the same level of production (which happens due to wage revisions at the micro level and deficit financing at the macro level). This is the typical case of creating extra money (either by printing or public borrowing) without equivalent creation in production/supply, i.e., ‘too much money chasing too little output’—the ultimate source of demand-pull inflation.

(ii) Cost-Push Inflation
Similarly, for the monetarists, ‘cost-push’ is not a truly indepen-dent theory of inflation—it has to be financed by some extra money (which is created by the government via wage revision, public borrowing, printing of currency, etc.). A price rise does not get automatically reciprocated by consumers’ purchasing. Basically, people must have got some extra purchasing power created that’s why they start purchasing at higher prices also. If this has not been the reason, people would have cut-down their consumption (i.e., overall demand) to the level of their purchasing capacity and the aggregate demand of goods would have gone down. But this does not happen. It means every cost-push inflation is a result of excessive creation of money—increasing money flow or money supply.
For the monetarists, a particular level of money supply for a particular level of production is healthy for an economy. Extra creation of money over the same level of production causes inflation. They suggested proper monetary policy (money supply, interest rates, printing of currencies, public borrowing etc.), to check situations of inflationary pressure on the economy. Monetarists rejected the Keynesian theory of inflation.

3. Measures to Check Inflation

Inflation being a socio-economically sensitive issue, governments across the world try several short and long-term policy steps to check it from getting uncomfortable—a brief idea about the steps are given below:

(i) Demand side measure: 
In this category mainly, two types of steps are taken. Firstly, the consumers are appealed to cut back the consumption of the items which show higher inflation (called austerity). This step has generally failed across the world because it does not work in case of essential items (such as wheat, rice, milk, tea, etc.) and as people who have money, they don’t wish to cut down consumption. Secondly, the government may tighten flow of money in the system (known as monetary measure)—central bank making money costlier (by increasing repo rate, increasing CRR, etc. in case of India). This step also has its own limitations—it is not effective if the items showing inflation are essential ones (such as wheat, rice, onion, potato, etc. because consumers don’t borrow money from banks to buy them). But it can be quite effective if the items are building materials (interest on home loan can be increased to cut back the demand of these items).

(ii) Supply side measure: 
Aimed at increa-sing the supply of the items showing inflation, the government may go in for upscaling the production or import of the items. This measure also has its own limitations—production may not be upscaled in short-run and import may not reach the country in time. Rather in medium and long-run, production of these items can be upscaled.

(iii) Cost side measure:
Two variety of steps may be taken under it—in short-run cutting taxes can bring in comfort but in the long-run cutting cost of production is the only way out (by scaling up technology)