A rise in general level of price, a sustained rise in the general level of prices in an economy that is sustained over time is inflation.
The rate of inflation is measured on the basis of price indices which are of two types- Wholesale Price Index and Consumer Price Index.
Types of Inflation:
- Low Inflation: Low inflation takes place in a longer period and the range of increase is usually in single digit.
- Galloping Inflation: This is very high inflation running in the range of double digit or triple digit.
- 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 range of increase is very large but the increase takes place in a very short span of time.
It is a graphic curve which advocates a relationship between inflation and unemployment in an economy. There is a trade off between inflation and unemployment. The curve suggests that lower the inflation, higher the unemployment and higher the inflation lower the unemployment.
Reflation: Reflation is a situation often deliberately brought by the government to reduce unemployment and increase demand by going for higher levels of economic growth. Government go for higher public expenditure, tax cuts, interest rate cuts, etc. Fiscal deficit rises, extra money is generally printed at higher level of growth, wages increase and there is almost no improvement in unemployment.
Stagflation: A combination of high inflation and low growth in the economy. When the economy is passing through cycle of stagnation and government shuffles with the economy policy, a sudden and temporary price rise is seen in some of goods, such inflation is known as stagflation.
Effects of Inflation
- On Creditors and Debtors: Inflation redistributes wealth from creditors to debtors, i.e., lenders suffers and borrowers benefit out of inflation. The opposite effect takes place when inflation falls.
- On Lending: With the rise in inflation, lending institutions feel pressure of higher lending. Institutions don’t revise the nominal rate of interest as the real cost of borrowing falls by the same percentage with which inflation rises.
- On Aggregate Demand: Rising inflation indicates rising aggregate demand and indicates comparatively lower supply and higher purchasing capacity among the consumers.
- On Investment: Investment in the economy boosted by the inflation.
- On Saving: For short term inflation, saving rate increases but for the long term, higher inflation depletes the saving rate in an economy.
- On Tax: Inflation increases the nominal value of the gross tax revenue while real value of the tax collection does not compare with the current pace of inflation as there is a delay in the tax collection in an economy.
- On Employment: Inflation increases employment in the short-run but becomes neutral or even negative in the long run.
- On Export and Import: Inflation gives an economy the advantage of lower imports as foreign goods become costlier. While exportable items of an economy gain competitive prices in the world market.
Four Phases of Economy
1. Depression: The economic situation becomes so chaotic in the phase of depression that governments have almost no control over the economy. The major traits of depression are-
(a) An extremely low aggregate demand in the economy causes activities to decelerates.
(b) The inflation being comparatively lower
(c) The employment avenues start shrinking forcing unemployment rate to grow fast
(d) To keep the business going, production houses go for forced labour-cuts .
2. Recovery: The business cycle of recovery may show the following major traits:
(a) An upturn in total demand which has to be accompanied by increase in the level of production.
(b) Production process expands and new investment become attractive.
(c) As demand goes upward, inflation also moves upward making borrowing cheaper for investors.
(d) With an upturn in production, new employment avenues are created and unemployment rate starts declining.
3. Boom: A strong upward fluctuation in the economic activities is called boom. The major economic traits of boom may be listed as given below:
(a) An accelerated and prolonged increase in the demand
(b) Demand peaks up to such a high level that it exceeds sustainable output/production levels
(c) The economy heats up and a demand-supply lag is visible.
(d) The market forces mismatch and tend to create a situation where inflation start going upward
4. Recession: There is a general fall in demand as economic activities takes a downturn. Inflation remains lower or/ and shows further signs of falling down. Employment rate falls/ unemployment rate grows, Industries resort to price cuts to sustain their business.