Table of Contents
Definition and Meaning of Inflation
Everyone is familiar with the term Inflation as rising prices. This means the same thing as fall in the value of money. Inflation is a monetary ailment in an economy and it is defined by economists in so many ways.
When there is a persistent and appreciable rise in the general level or average of prices, we have inflation.
Crowther defines inflation as
a state in which the value of money is falling, i.e., prices are rising.
Pigou defines inflation as a condition
when money income is expanding relatively to the output of work done by the productive agents for which it is the payment.
Coulbourn defines it as
too much money chasing too few goods.
T.E.Gregory calls inflation as
a state of abnormal increase in the quantity of purchasing power.
All these definitions indicate one basic phenomenon in the economy. Too much of money in circulation compared to too little goods produced leading to extraordinary increase in prices. This is what is called the quantity approach to the rise in price level. It should be noted here that high prices should not be construed as inflation. It is only a persistent increase in prices to an abnormal extent which should be termed inflation.
Keynes’ Definition regarding Inflation
While increase in volume of money is responsible for rise in the price level, Keynes relates inflation and rise in prices as follows.
- It comes into existence after the stage of full employment.
- Rise in prices may be accompanied by an increase in production.
- Rise in prices not accompanied by increase in production.
If an economy is working at a low level with a number of unemployed people and resources, an expansion of money or other factors will not only increase the prices due to increase in demand, but also increase the volume of goods and services produced in the system. This is the case of rise in prices accompanied by increased production and employment. This condition will continue till all the unemployed factors are fully utilized, i,e., a stage of full-employment is reached. Beyond this stage, however, any expansion in the volume of money will only lead to rise in prices and not rise in production or employment.
Keynes opines that the stage of increasing prices with increasing output and employment is desirable. Such a type of increasing prices is called Reflation or partial inflation which helps the economy to move towards full employment condition. But increasing prices after full employment is bad, as there will not be any increase in the production of goods or increase in employment. Hence in the Keynesian sense, inflation refers to a rise in the price level after full employment is reached.
But in an underdeveloped country, the term ‘inflation’ cannot be use in the Keynesian sense. A country advancing towards full employment condition may show signs of inflation. This does not mean that countries having inflationary conditions signify that they are moving towards full employment. In a country like India, we can witness ‘inflation’ and ‘unemployment’ existing side by side.
Abnormal rise in prices and persistent rise in prices are in no way an indication of prosperity and that the country is moving towards full employment. On the other hand, the backlog of unemployment is mounting up year after year. Hence we see a condition of stagnation with inflation. So, we should be able to distinguish between inflation in the midst of prosperity and inflation in the midst of poverty. The former is desirable.
The inflationary spiral in backward and developing economies is due to the existence of bottlenecks, such as limited amount of capital and machinery, transport facilities and the lack of technical know-how. As a result of these bottlenecks and shortages, an increased volume of money will lead to increased prices, but will not lead to increased output beyond a certain stage, even though the country may not have reached the stage of full employment.
Characteristics of Inflation
1. Persistent rise in prices
The first characteristic feature of inflation is the persistent rise in prices. This conclusion is based on observation of facts and it is by an large correct. Though there may be recovery of prices here and there due to monetary and fiscal measures undertaken by the government, it is an agreed fact that excessive rise in prices is the hallmark of inflation.
2. Excessive supply of money in economy
The second feature of inflation is an excessive supply of money in the economy. In times of war or sudden preparations for war, the resources at the disposal of the government may not be sufficient and the government may adopt war time measures to augment the resources to meed the emergent situation. The government may resort to banks which make advances on the basis of government bonds and securities. This result in an expansion in the paper currency as well as bank credit in the economy.
3. Vicious circle of inflationary spiral
Another important characteristic feature of inflation is the vicious circle of inflationary spiral created by the velocity of circulation of money. Inflation will feed on itself to grow into an inflationary spiral.
Since the prices are rising and also expected to rise, the community will have the least inclination to save money or hold cash assets as the value of money is decreasing.
There will be strong tendencies to spend more in commodities and services, not only for the current period, but also for future. The tendency will be strong and persistent in hoarding stock of goods, the prices of which are increasing. People will try to invest on real-estate and other tangible assets whose prices will increase with inflation. The people will try to capitalize on the increasing prices and decreasing value of money.
On the other hand, businesses anticipating increased demand for goods will be expanding their investment programmes. Thus spending on both accounts will be speeded up. The velocity of money will be at a very-high level.
Increased prices and supply of money may not result in increased goods either because the economy in production. These bottlenecks cause a further hike in price due to high demand.
Rising prices will lead to increased wages and costs which will lead to further increase in prices. More of bank money will lead to more of spending. Thus the vicious circle once started will continue to feed itself.