What is Inflation and Types of Inflation and How Does it Affect Our Economy?

 

Inflation: Causes, Definitions, and Key Features

Pigou defines inflation as the expansion of money income in relation to the productive output of the agents receiving payment. He also states that inflation occurs when money income expands disproportionately to income-earning activity.

R. C. Hawtrey associates inflation with the issuance of an excessive amount of currency, while T. T. Gregory describes it as an abnormal increase in purchasing power. In general, inflation can be defined as a sustained increase in the overall price level resulting from high rates of growth in the aggregate money supply.

These definitions share a common feature, emphasizing that inflation is a process of rising prices rather than a state of already high prices. They indicate a state of imbalance between aggregate supply and demand at the prevailing price level.

In simpler terms, prices rise due to an increase in the money supply relative to the supply of goods. This perspective aligns with the quantity theory of price change. However, it is important to note that price increases in a dynamic economy can also occur due to factors unrelated to the aforementioned causes.

Keynes disagrees with the quantity theory approach, which holds that the volume of money is responsible for price increases. Instead, he argues that inflation is caused by an excess of effective demand. According to Keynes, true inflation only begins after reaching full employment, where employment changes in proportion to changes in the quantity of money, and prices change accordingly.

Keynes believes that we need not excessively fear inflation because as long as there are unemployed resources, an increase in the money supply will stimulate employment. Only after reaching full employment will increases in the money supply lead to a rise in the price level. Keynes acknowledges that prices may rise even before full employment, which he refers to as "semi-inflation" or "bottleneck inflation."

Keynes introduced the concept of the inflationary gap. This refers to a situation in the economy where anticipated expenditures exceed the available output at base or pre-inflation prices. The inflationary gap represents the difference between disposable income and the output available for consumption.

Essentially, when increased investment or government expenditures, or both, cause money income to rise but the capacity to produce goods and services cannot keep up, an inflationary gap emerges, leading to price increases. It arises when the total money income available for consumption exceeds the total output at pre-inflation prices.

Key features of inflation include:

1. Inflation always involves a rise in prices, representing a continuous increase.
2. Inflation is primarily an economic phenomenon originating from within the economic system and influenced by economic forces.
3. Inflation is a dynamic process observable over an extended period.
4. It is important to distinguish between cyclical movements and inflation.
5. Inflation is primarily a monetary phenomenon caused by excessive money supply.
6. True inflation occurs only after reaching full employment.

Types of Inflation

Classification of Inflation: Exploring Different Types

Inflation can be categorized based on various factors, particularly the degree of price rise. The following types of inflation can be distinguished:

1. Creeping Inflation: This refers to the mildest form of inflation, which is generally considered non-threatening to the economy. Some economists even view it as a beneficial tool for promoting economic development, as it helps prevent stagnation. However, there are differing opinions, and some argue that creeping inflation should be addressed promptly to avoid potential escalation.

2. Walking Inflation: Walking inflation represents a slightly faster pace of price increases compared to creeping inflation. It serves as an early warning sign of potential hyperinflation. When the rate of price rise accelerates beyond walking inflation, it enters the realm of running inflation.

3. Running Inflation: Running inflation occurs when prices escalate at a rapid pace, surpassing the rate observed in walking inflation. This indicates a higher level of inflationary pressure within the economy.

4. Jumping or Galloping or Hyperinflation: Hyperinflation signifies the most extreme form of inflation, where prices surge continuously and there is virtually no limit to how high they can climb. Hyperinflation is an alarming indication of severe instability in a country's monetary system. It significantly devalues fixed-income assets such as salaries, savings, bonds, and other financial instruments.

In summary, the classification of inflation encompasses various types based on the speed and intensity of price increases. From the mild creeping inflation to the extreme hyperinflation, each type carries distinct implications for the economy and the value of financial assets.