Types of Inflation and Measures to Control It

Inflation

Types of Inflation

Inflation can be classified into three main types: demand-pull inflation, cost-push inflation, and built-in inflation.

Demand-Pull Inflation

This type of inflation arises when buyers demand more goods and services than sellers can produce, causing prices to rise. This scenario happens due to increased levels of economic activity, overconsumption, or rapid population growth.

Cost-Push Inflation

Cost-push inflation occurs when producers face rising costs for raw materials or wages, forcing them to raise prices to cover these additional expenses. Sometimes, this type of inflation can be caused by union demands for higher wages or increased taxes in the country.

Built-In Inflation

Built-in inflation refers to a situation where wage setters and price setters anticipate that inflation will continue in the future and adjust wages and prices accordingly. It results from workers demanding higher pay to keep pace with the rising costs of goods and services, leading to an upward spiral of increasing prices and wages.

Measuring Inflation

Inflation is measured by comparing the average change in prices for a basket of goods and services over a period of time. Two widely used measures for tracking inflation are the Consumer Price Index (CPI) and the Wholesale Price Index (WPI).

Consumer Price Index (CPI)

The CPI is an average measure of the change in retail prices of a basket of consumer goods and services purchased by households.

Wholesale Price Index (WPI)

The WPI tracks price changes for wholesale goods produced by manufacturers, which can be seen as an indicator of input costs for businesses.

Causes of Inflation

There are several causes of inflation, including monetary factors, fiscal factors, structural factors, supply shocks, and demand shifts.

Monetary Factors

An increase in the money supply can lead to inflation as it puts downward pressure on interest rates and encourages borrowing and spending.

Fiscal Factors

Government deficit financing or increased expenditure can contribute to inflation if it exceeds the economy's productive capacity.

Structural Factors

Structural factors, such as changes in economic policies, institutional changes, or technological developments, can influence inflation.

Supply Shocks

Unexpected reductions in the availability of goods and resources can lead to inflation as sellers raise prices to capture windfall profits.

Demand Shifts

Changes in tastes or preferences can shift demand towards certain goods, causing relative price increases and potentially contributing to inflation.

Strategies to Control Inflation

Central banks employ strategies to control inflation, which mainly revolve around managing the money supply and setting interest rates. These strategies include:

Monetary Policy Tools

Tools like short-term interest rates can be adjusted to achieve and maintain inflation.

Communication Strategy

Forward guidance refers to central bank communications about the likely future course of monetary policy, which can influence inflation expectations.

Effects of Inflation

The effects of inflation can be positive or negative depending on individual viewpoints and the rate of change. Those who benefit most from inflation are those with tangible assets, such as property, stocked commodities, or strong currencies, as the value of these assets tends to appreciate with inflation.