Inflation – Overview, Types, Causes, Impacts, and Solutions

As a consumer, you often face a sudden increase in the prices of goods and services, which affects your ability to purchase certain goods. This hypothetical, speculative and unpredictable situation of a rise in price is inflation. There are different causes behind it, which are sometimes controllable and sometimes uncontrollable. This blog provides a detailed overview of inflation, different types of inflation, its causes, and how to measure it.

What is Inflation?

When the price of goods and services increases suddenly or gradually, resulting in a loss of purchasing power of consumers, it is called inflation. In this unpredictable situation, consumers buy fewer goods or services due to an increase in their price. The rate of inflation differs depending on the circumstances prevailing in the market.

To calculate the rate of inflation, one year of data is used as follows:

Rate of Inflation = (Price in this period – Price in the previous period)  100/ Price in the previous year

If the rate of inflation is high, it reflects a rapid increase in prices and a sharp decline in purchasing power. On the other hand, if the rate of inflation is low, it reflects that prices are rising slowly.

Different Types of Inflation

In an economy, to simplify the understanding of inflation, it is categorised as:

• Inflation based on rates
• Inflation based on causes

1. Inflation Based on Rates

Based on the rate of increase in price, inflation is categorised as creeping inflation, galloping inflation, walking inflation, or hyperinflation. Let’s have an overview of these to understand them better.

Creeping Inflation

Sometimes, in the economy or market, this inflation is also regarded as mild or low inflation. In this type of inflation, the increase in price is gradual or moderate, which is less than 3% annually. This inflation is considered manageable and does not affect the demand and supply on a large scale. This inflation is good for the growth of the economy as the prices increase slowly but continuously, allowing traders and manufacturers to make reasonable profits.

Walking Inflation

This inflation is sometimes referred to as trotting inflation, which reflects a rise in price faster and higher than the creeping inflation. In this type of inflation, the hike in price is between 3%-10% annually. The Government need to regularly monitor this kind of inflation to avoid economic overheating. When walking inflation is not controlled on time, it leads to galloping inflation.

Galloping Inflation

When the inflation rate exceeds 10% but is less than 50%, it is known as galloping, hopping, or running inflation. Due to this inflation, the price of goods or services increases, significantly impacting the functioning of businesses and the overall economy.

HyperInflation

Hyperinflation occurs when the rate exceeds 50% reflecting an extreme increase in price where the domestic currency value almost reduces to zero. It is caused by a high supply of money in the market and shows an alarming or threatening situation. In this type of extreme level inflation, the money ceases to have any value or act as a medium of exchange.

2. Inflation Based on Causes

Based on underlying causes, there are different types of inflation, namely:

Demand-Pull Inflation

When the increase in demand and consumption simultaneously lead to an increase in price of goods, it is called demand-pull inflation. The reason behind this type of inflation is the sudden or significant increase in the disposable income of households/consumers. The increase in income proportionately leads to an increase in demand and consumption, while the aggregate supply remains the same.

Cost-Push Inflation

In an economy, there are multiple factors of production that contribute to its growth, like land, labour, capital and entrepreneur. When the process of these factors increases, the prices of goods and services increase proportionately, leading to inflation in the stock market. When in an economy, the cost of one or more inputs of production increases, it leads to an increase in the price, making the goods or services costlier compared to the previous price.

Supply-Shock Inflation

When an unexpected or sudden fall in the supply of goods leads to a shocking and sharp increase in the price of goods, it is a situation of supply-shock inflation. The factor affecting the supply remains out of the control of the firms or employers. The price of the goods remains high until or unless the supply is increased to fulfil all the demands.

Structural Inflation

When the price of goods and services increases due to insufficient storage facilities, poor productivity, or any other imbalance or deficiencies in the economy, it leads to structural inflation. This poor structure or facilities leads to a shortage of supply in the market, resulting in a hike in the price of goods.

Causes of Inflation

The primary cause of inflation is generally either the increase in price of goods or services due to a shortage of supply, insufficient supply, excessive money supply or high demand for goods. However, there are other factors as well that cause inflation. These include:

1. When the workers demand comparatively high wages to meet the expenses or an increase in price, the business increases the price of goods to meet workers’ demand, leading to inflation.
2. Various government policies and measures, like an increase in public spending or increase in tax, affect the demand and supply in the market, causing inflation.
3. Banking activities or policies, such as lowering interest rates, affect the borrowing and spending activities of consumers, leading to an increase in demand and inflation.
4. Natural disasters like earthquakes, tsunamis, floods, or heavy rains lead to a decrease in the supply of necessary or essential goods, leading to a huge increase in demand, which causes inflation.

How to Compute Inflation?

Among the various options to compute inflation, the most common method is to use a price index. The index compares the current prices of the goods with reference to the base year and reflects the changes. In India, two major price indexes are used to measure inflation, namely:

1. Wholesale Price Index

The Wholesale Price Index is a key indicator to measure inflation using the change in pattern or price in the wholesale market. It tracks the goods traded or distributed by companies. It does not include services and calculated inflation on the wholesale level only.

2. Consumer Price Index

The Consumer Price Index is used by the Government and other regulated authorities to examine the periodic changes in the price of a particular basket of goods and services. It examines the different prices paid by the consumer for the same basket of goods.

Measures to Control Inflation

There are various measures used by the Government of India or the Reserve Bank of India, depending on the situation, to tackle the situation of inflation. Some of them are:

1. Monetary Measures

The RBI uses monetary tools like reducing the money supply, demonetization of currency or increasing borrowing rates to reduce the supply of money and demand for goods in the market.

2. Fiscal Measures

To reduce the impact of inflation Government takes some measures like reduction in expenditure, an increase in direct and indirect taxes, or passing a surplus budget. This reduces the demand, disposable income, and ultimately brings down the prices.

3. Trade Measures

Whenever there is a decrease in supply resulting in high prices of goods, various trade measures are taken to increase the supply of goods. Usually, traders or manufacturers import goods from other countries to meet the high demand and reduce the price of goods.

4. Administrative Measures

The government take various administrative measures to reduce the price and demand in the market. Many times government offer a rational wage policy and sets maximum price limits to keep the demand in control.

The Closing Statement

Inflation is an integral part of an economy that influences the prices of goods or services, government policies, financial policies and economic decisions. To cope with inflation, the Government need to carefully balance the monetary, fiscal, administrative, and trade measures. The government need to regularly monitor inflation and regulate it to protect the purchasing power of consumers and the value of money. Frequently Asked Questions

FAQs about Inflation Overview