INFLATION

Inflation means a persistent rise in the price levels of commodities and services, leading to a fall in the currency’s purchasing power. The problem of inflation used to be confined to national boundaries, and was caused by domestic money supply and price rises.  The rate at which the general level of prices for goods and services is rising, and, subsequently, purchasing power is falling. Central banks attempt to stop severe inflation, along with severe deflation, in an attempt to keep the excessive growth of prices to a minimum.

                                                In this era of globalization, the effect of economic inflation crosses borders and percolates to both developing and developed nations. The overall general upward price movement of goods and services in an economy (often caused by a increase in the supply of money), usually as measured by the

1. Consumer Price Index
2. The Producer Price Index
3. Commodity price indices
4. Core price indices

CPI  can be defined as a  measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care. The CPI is calculated by taking price changes for each item in the predetermined basket of goods and averaging them; the goods are weighted according to their importance. Changes in CPI are used to assess price changes associated with the cost of living. Sometimes referred to as "headline inflation."

Producer Price Index (PPI) program measures the average change over time in the selling prices received by domestic producers for their output. The prices included in the PPI are from the first commercial transaction for many products and some services

Commodity price indices, which measure the price of a selection of commodities. In the present commodity price indices are weighted by the relative importance of the components to the "all in" cost of an employee.

Core price indices: because food and oil prices can change quickly due to changes in supply and demand conditions in the food and oil markets, it can be difficult to detect the long run trend in price levels when those prices are included. Therefore most statistical agencies also report a measure of 'core inflation', which removes the most volatile components (such as food and oil) from a broad price index like the CPI. Because core inflation is less affected by short run supply and demand conditions in specific markets, central banks rely on it to better measure the inflationary impact of current monetary policy.

Types of Inflation

1.       Regional Inflation,

2.       Built-in Inflation

Regional Inflation indicates the ability of a region to participate in the currency union, for impacting its inflation differential with regard to the union. This impact, however, can be created through implementation of fiscal policy. In fact, Regional Inflation can be well-understood if one carefully notices the inter-relations between the inflation differentials and the regional fiscal policy in a two-region flexible price model, with respect to both traded and non-traded commodities.

 Built-in Inflation is that kind of inflation which evolve from the past events and continues to affect the current economical conditions of a nation. Built-in Inflation that it may also be termed as Hangover Inflation.

Cause of  Inflation

The following factors can lead to inflation:

1. Excess Flow of Money
2. Increases in production costs.
3. Tax rises.
4. Declines in exchange rates.
5. Decreases in the availability of limited resources such as food or oil.
6. War or other events causing instability.

Effects of Inflation

 If a country has a higher rate of inflation than other countries, its balance of trade is likely to move in an unfavorable direction. This is because there is a decline in its price competitiveness in the global market. A high rate of inflation can cause the following economic impediments:

1.      The value of investments are destroyed over time.

2. It is economically disastrous for lenders.
3. Arbitrary governmental control of the economy to control inflation can restrain economic development of the country.
4. Non-uniform inflation can lead to heavy competition in the global market and threaten the existence of small economies.
5. High levels of inflation tend to lead to economic stagnation

Measures to control Inflation

The central banks, monetary authorities or finance ministries of most nations have the authority to take economic measures to control rising inflation by regulating the following factors:

1.      Reducing the central bank interest rates and increasing bank interest rates.

2. Regulating fixed exchange rates of the domestic currency.
3. Controlling prices and wages.
4. Providing cost of living allowance to citizens in order to create demand in the market.
5. Inflating targeting

Costs of inflation

Problems arise when there is unanticipated inflation:

• Creditors lose and debtors gain if the lender does not guess inflation correctly. For those who borrow, this is similar to getting an interest-free loan.
• Uncertainty about what will happen next makes corporations and consumers less likely to spend. This hurts economic output in the long run.
• People living off a fixed-income, such as retirees, see a decline in their purchasing power and, consequently, their standard of living.
• The entire economy must absorb repricing costs ("menu costs") as price lists, labels, menus and more have to be updated.
• If the inflation rate is greater than that of other countries, domestic products become less competitive.
• nominal interest rate rise because inflation is anticipated

Conclusion

During the last decade, inflation has been a major economic problem in most developed countries. Efforts to control inflation have been ineffectual, however, and inflation rates have consistently exceeded targets. Substantial social costs have been imposed as a consequence.