TYPES OF INFLATION

Depending upon the range of increase, and its severity, inflation may be classified into three broad categories.

1. Low Inflation

Such inflation is slow and on predictable lines, which might be called small or gradual . This is a comparative term which puts it opposite to the faster, bigger and unpredictable inflations. Low inflation takes place in a longer period and the range of increase is usually in ‘single digit’. Such inflation has also been called as ‘creeping inflation’. We may take an example of the monthly inflation rate of a country for six months being 2.3 per cent, 2.6 per cent, 2.7 per cent,2.9 per cent, 3.1 per cent and 3.4 per cent. Here the range of change is of 1.1 per cent and over a period of six months.

2. Galloping Inflation

This is a ‘very high inflation’ running in the range of double-digit or triple digit (i.e., 20 per cent, 100 per cent or 200 per cent in a year). In the decades of 1970s and 1980s, many Latin American countries such as Argentina, Chile and Brazil had such rates of inflation—in the range of 50 to 700 per cent. The Russian economy did show such inflation after the disintegration of the ex-USSR in the late 1980s.
Contemporary journalism has given some other names to this inflation—hopping inflation, jumping inflation and running or runaway inflation

3. Hyperinflation

This form of inflation is ‘large and accelerating’ which might have the annual rates in million or even trillion. In such inflation not only the range of increase is very large, but the increase takes place in a very short span of time, prices shoot up overnight.
The best example of hyperinflation that economists cite is of Germany after the First World War—in early 1920s. At the end of 1923, prices were 36 billion times higher than two years earlier. This inflation was so severe that paper German currencies (the Deutsche Mark) were more valuable as stove fuel than as actual money. Some recent examples of hyperinflation had been the Bolivian inflation of mid-1985 (24,000 per cent per annum) and the Yugoslavian inflation of 1993 (20 per cent per day). The latest example has been Venezuela which saw an annual inflation of over 53 million per cent by 2019, as per its central bank. The currency of Zimbabwe was declared worthless (by the magazine The Economist) in wake of rise in annual inflation to 90 billion trillion per cent by 2008.
Such an inflation quickly leads to a complete loss of confidence in the domestic currency and people start opting for other forms of money, as for example physical assets, gold and foreign currency (also known as ‘inflation proof’ assets) and people might switch to barter exchange.

OTHER VARIANTS OF INFLATION

Other than the three broad categories we analysed above, some other variants of inflation are also considered by governments in their policymaking:

1. Bottleneck Inflation

This inflation takes place when the supply falls drastically and the demand remains at the same level. Such situations arise due to supply-side hurdles, hazards or mismanagement which is also known as ‘structural inflation’. This could be put in the ‘demand-pull inflation’ category.

2. Core Inflation

This nomenclature is based on the inclusion or exclusion of the goods and services while calculating inflation. Popular in western economies, core inflation shows price rise in all goods and services excluding energy and food articles. First used in India in 2000–01 it does not suit our inflation analysis in the right sense because prices here depend more on food articles and energy. Since 2015–16, a new core-core inflation is also measured by India which excludes food, fuel & light, transport and communication.

OTHER IMPORTANT TERMS

Inflationary Gap

The excess of total government spending above the national income (i.e., fiscal deficit) is known as inflationary gap. This is intended to increase the production level, which ultimately pushes the prices up due to extra-creation of money during the process.

Deflationary Gap

The shortfall in total spending of the government (i.e., fiscal surplus) over the national income creates deflationary gaps in the economy. This is a situation of producing more than the demand and the economy usually heads for a general slowdown in the level of demand. This is also known as the output gap.

Inflation Tax

Inflation erodes the value of money and the people who hold currency suffer in this process. As the governments have authority of printing currency and circulating it into the economy (as they do in the case of deficit financing), this act functions as an income to the governments. This is a situation of sustaining government expenditure at the cost of people’s income. This looks as if inflation is working as a tax. That is how the term inflation tax is also known as seigniorage. It means, inflation is always the level to which the government may go for deficit financing—level of deficit financing is directly reflected by the rate of inflation. It could also be used by the governments in the form of prices and incomes policy under which the companies pay inflation tax on the salary increases above the set level prescribed by the government.

Inflation Spiral

An inflationary situation in an economy which results out of a process of wage and price interaction ‘when wages press prices up and prices pull wages up’ is known as the inflationary spiral. It is also known as the wage-price spiral. This wage-price interaction was seen as a plausible cause of inflation in the year 1935 in the US economy, for the first time.

Inflation Accounting

A term popular in the area of corporate profit accounting. Basically, due to inflation the profit of firms/companies gets overstated. When a firm calculates its profits after adjusting the effects of current level of inflation, this process is known as inflation accounting. Such profits are the real profit of the firm which could be compared to a historic rate of inflation (inflation of the base year), too.

Inflation Premium

The bonus brought by inflation to the borrowers is known as the inflation premium. The interest banks charge on their lending is known as the nominal interest rate, which might not be the real cost of borrowing paid by the borrower to the banks. To calculate the real cost a borrower is paying on its loan, the nominal rate of interest is adjusted with the effect of inflation and thus the interest rate we get is known as the real interest rate. Real interest is always lower than the nominal interest rate, if the inflation is taking place—the difference is the inflation premium

INFLATION TARGETING

The announcement of an official target range for inflation is known as inflation targeting. It is done by the Central Bank in an economy as a part of their monetary policy to realise the objective of a stable rate of inflation (the Government of India asked the RBI to perform this function in the early 1970s).
India commenced inflation targeting ‘formally’ in February 2015 when an agreement between the GoI and the RBI was signed related to it—the Agreement on Monetary Policy Framework. The agreement provides the aim of inflation targeting in this way—’it is essential to have a modern monetary framework to meet the challenge of an increasingly complex economy. Whereas the objective of monetary policy is to primarily maintain price stability, while keeping in mind the objective of growth.’ The highlights of the agreement is as given below:
  The RBI will aim to bring CPI-C Inflation below 6 per cent by January 2016. The target for financial year 2016–17 and all subsequent years shall be 4 per cent with a band of +/– 2 per cent (it means the ‘healthy range of inflation’ to be 2–6 per cent).

•   RBI to publish the Operating Target(s) and establish an Operating Procedure of monetary policy to achieve the target. Any change in the operating target(s) and operating procedure in response to evolving macro-financial conditions shall also be published.

Every six months, the RBI to publish a document explaining:

1. Source of inflation;
2. Forecasts of inflation for the period between six to eighteen months from the date of the publication of the document; and

•   The RBI shall be seen to have failed to meet the target if inflation is:

1. More than 6 per cent for three cons-ecutive quarters for the financial year 2015–16 and all subsequent years.
2. Less than 2 per cent for three cons-ecutive quarters in 2016–17 and all subsequent years.
3.   If the RBI fails to meet the target it shall set out in a report to the GoI:
4.  the reasons for its failure to achieve the target under set in this agreement;
5. remedial actions proposed to be taken by the RBI; and
6. an estimate of the time-period within which the target would be achieved pursuant to timely implementation of proposed remedial actions.

•   Any dispute regarding the interpretation or implementation of the agreement to be resolved between the Governor, RBI and the GoI.

It should be noted that the Urjit Patel Committee setup by the RBI on monetary policy gave similar advices by early 2014—the move is seen as a follow up to this. This way India joined the club of inflation targeting countries such as USA, UK, European Union, Japan, South Korea, China, Indonesia and Brazil. It was New Zealand which went for inflation targeting in 1989 for the first time in the world.

Skewflation

Economists usually distinguish between inflation and a relative price increase. ‘Inflation’ refers to a sustained, across-the-board price increase, whereas ‘a relative price increase’ is a reference to an episodic price rise pertaining to one or a small group of commodities. This leaves a third phenomenon, namely one in which there is a price rise of one or a small group of commodities over a sustained period of time, without a traditional designation. ‘Skewflation’ is a relatively new term to describe this third category of price rise.
In India, food prices rose steadily during the last months of 2009 and the early months of 2010, even though the prices of non-food items continued to be relatively stable. As this somewhat unusual phenomenon stubbornly persisted, policymakers conferred on how to bring it to an end. The term ‘skewflation’ made an appearance in internal documents of the Government of India, and then appeared in print in the Economic Survey 2009–10 GoI, MoF. The skewedness of inflation in India in the early months of 2010 was obvious from the fact that food price inflation crossed the 20 per cent mark in multiple months, whereas wholesale price index (WPI) inflation never once crossed 11 per cent. It may be pointed out that the skewflation has gradually given way to a lower-grade generalised inflation (with the economy in the middle of 2011 inflating at around 9 per cent with food and non-food price increases roughly at the same level).
Given that other nations have faced similar problems, the use of this term picked up quickly, with the Economist magazine (January 24, 2011), in an article entitled ‘Price Rises in China: Inflated Fears’, wondering if China was beginning to suffer from an Indian-style skewflation.