Inflation and Its Classification
Inflation refers to the situation where prices exhibit a continuously increasing trend. Inflation is defined as too much money chasing too few goods by Coulborn. Geofrfrey Crowther states that inflation is a state in which the value of money is falling and the prices are raising.
Inflation, economic growth and price stability
Governments world over attempt to accelerate economic growth with price stability. The monetary value of output tends to increase when high inflation rate exists. This in effect reduces the purchasing power of consumers as inflation decreases the value of money. However, price stability does not mean zero inflation as mild inflation boosts the confidence of investors as they can derive fair returns on their investment. Rather than avoiding inflation, governments are trying to achieve economic growth with mild inflation. Central banks, including the Reserve Bank of India, try to achieve price stability by maintaining low, stable and predictable inflation. For, RBI one of the major roles is achieving growth through inflation targeting.
Inflation can be classified based on magnitude, causes or nature.
Inflation on the basis of magnitude
When the rise in price level is slow, it is called creeping inflation. In this case the rate is less than 3% per annum. This rate is regarded as safe and essential for economic growth. When the annual rate of price rise is more than 3%, but less than 10%, it is called walking or trotting inflation and is a warning signal for governments to exercise controls. The running inflation is characterized by the price increase rate between 10% and 20% and is highly damaging to poor and middle classes. During galloping or jumping inflation, the price rise is in double digits and more than 20%. In 1970s and 1980s countries like Chile, Brazil and Argentina witnessed inflation in the range of 50% to 70%. When the price rises very fast at triple digit or more per annum it is called hyperinflation. During this stage price rise is beyond control. Price may even rise multiple times in a day and people loss confidence in the domestic currency. Bolivia had inflation at the rate 24000% per annum during mid 1985 and Yugoslavia had an inflation rate of 20% per day in 1993.
Inflation on the basis of causes
The prices can rise when there is more money and less supply of products. When more money chases less quantity of goods, demand pushes up prices of goods and service. Such inflation is called demand pull inflation. Prices can go up because of increase in cost of production. The cost-push inflation can occur due to increases in wages or when produces increases prices to increase profits. These are called wage push inflation and profit push inflation respectively. Hang over or built in inflation occurs due to combination of demand pull and cost pull inflation.
Structural inflation arises from structural rigidities and bottlenecks and occurs when demand remains same but supply falls drastically. Agricultural bottlenecks reduce agricultural supply increasing the prices of food grains and leading to food inflation. When governments opt for deficit financing, by spending beyond revenue by printing money, it leads to inflation. Foreign exchange constrains leads a country to Balance of Payment (BOP) issues causing to devalue the currency. Devaluation increases inflation as imports becomes costly and output in domestic market decreases due to increase in exports.
Inflation on the basis of coverage
Comprehensive inflation (economy wide inflation) occurs when the prices of all commodities throughout the economy rise. Sporadic inflation is sectional in nature and it occurs when prices of only few commodities in few regions rise.
Inflation based on government reaction or its degree of control
In a free market economy, prices are allowed to take its own course based on demand and supply and government does not attempt to control inflation. This method is called open inflation. When government prevents price rise through price controls, rationing etc, it is known as suppressed or repressed inflation. It leads to black marketing, corruption, artificial scarcity etc. When controls are removed, it becomes open inflation.
For measurement of inflation, Price Indices are used; main among the price indices used in India are Wholesale Price Index (WPI) and Consumer Price Index (CPI).
