Inflation

Inflation is a sustained rise in the general price level of goods and services over a period of time, accompanied by a fall in the value of money. Two words matter: sustained (a one-off jump in a single price is not inflation) and general (the average of many prices, not just one commodity). Its opposite, deflation, is a sustained fall in the general price level.

Causes of inflation

Inflation is usually classified by its cause into two broad types.

1. Demand-pull inflation arises when aggregate demand rises faster than the economy's ability to produce goods — 'too much money chasing too few goods'. When buyers wish to spend more than the economy can supply at current prices, prices are pulled up. Its sources include:

• increases in the money supply and easy credit,
• rising government spending and budget deficits,
• higher consumer spending, rising exports, or a fall in saving.

2. Cost-push inflation arises from the supply/cost side, when the costs of production rise and firms pass the higher costs on as higher prices, even when demand has not increased. Its sources include:

• rising wages (wage-push),
• higher prices of raw materials and imported inputs (e.g. a rise in crude-oil prices),
• higher indirect taxes, and increases in profit margins by firms with market power.

Effects of inflation on different sections of society

Inflation does not hurt everyone equally — it redistributes income and wealth, which is why it is socially important.

• Debtors gain, creditors lose. A borrower repays a loan in rupees that are worth less than the rupees borrowed, so debtors gain at the expense of lenders.
• Fixed-income groups lose. Salaried employees, pensioners, and workers on fixed wages, and those living on fixed interest or rent, find their real income shrinking as prices rise.
• Producers, traders and speculators generally gain, because the prices of their goods and assets rise faster than their costs, widening profit margins.
• Savers lose as the real value of past savings and bank balances erodes; holders of real assets (land, gold, property) tend to gain.
• For the economy as a whole, mild inflation can encourage investment and production, but high or runaway inflation discourages saving, distorts decisions, worsens inequality and can cripple the economy.

Measures to control inflation (brief)

• Monetary measures taken by the central bank to reduce the money supply and credit — raising the bank rate/repo rate, raising the cash reserve ratio (CRR), and selling securities in the open market.
• Fiscal measures taken by the government — reducing public expenditure, raising taxes, and running a surplus budget to cut excess demand. …