Understanding Inflation and Deflation

• Inflation and deflation are economic phenomena related to the price level of goods and services in a country

Inflation

• Inflation is defined as the continuous rise in the price of goods and services
• It results from a large volume of money in circulation relative to the available goods and services

Measurement of Inflation

• There are three major measures of inflation

Wholesale Price Index

• Measures the price of inputs used in the production of goods

Consumer Price Index

• The main determinant of the level of inflation in a country
• Measures the changes in the price level of consumer goods
• CPI = (Current year price index / Base year price index) x 100

GDP Index

• Measures changes in the total value of goods and services produced in a country over a period

Types of Inflation

Demand-pull Inflation

• Occurs when demand for goods and services exceeds supply
• Often caused by increases in salaries/wages or population explosion
• Results in consumers having high purchasing power, increasing aggregate demand

Cost-push Inflation

• Rise in prices caused by increased costs of factors of production
• Higher production costs passed to consumers as higher prices

Hyperinflation or Galloping Inflation

• Prices rise at a fast rate, and money loses value as a medium of exchange
• Also called runaway inflation
• War and deficit budgets are major causes

Persistent or Creeping Inflation

• Continuous and difficult-to-control rise in prices
• Results from a large volume of money in circulation relative to available goods and services
• Also called chronic inflation

Causes of Inflation

• Demand exceeding supply
• Decrease in production
• War
• Increase in the cost of production
• Monopoly
• Hoarding
• Over-population
• Poor weather
• Deficit budget
• Increase in salaries and wages

Economic Effects of Inflation

• High profits for businessmen
• Reduction in the value of money
• Fixed-income earners suffer
• Fall in the standard of living
• Debtors gain
• Creditors lose
• Escalation of hunger
• Discourages savings
• Causes a deficit balance of payments
• Discourages investment
• Consumers suffer in general

How to Control Inflation

• Implement a surplus budget
• Increase direct taxes
• Use modern technology
• Increase the bank rate
• Use open market operations
• Implement effective price control systems
• Avoid industrial strikes
• Increase agricultural productivity
• Provide storage facilities
• Check the activities of hoarders
• Promote industrialization
• Use import substitution strategy

Deflation

• Deflation is defined as the continuous fall in the price level of goods and services in a country
• It results from a decrease in the volume of money in circulation
• Deflation is the opposite of inflation

Causes of Deflation

• Surplus budget or reduction in government expenditure
• Increase in production
• Compulsory bank savings
• Excessive price control
• Increase in taxation
• Increase in bank rate
• Under-population

Effects of Deflation

• Fall in prices of goods and services
• Reduction in profit
• Discourages savings
• Decrease in investment
• Causes unemployment
• Money lenders gain at the expense of borrowers
• Encourages exports
• Discourages imports
• Improvement in the balance of payments
• Fixed income earners gain
• Money gains more value

How to Control Deflation

• Implement a deficit budget
• Increase in wages
• Reduction in income tax
• Reduction in bank rate
• The use of open market operation
• "Deflationary gan" (Likely a typo, should be "gap", referring to addressing the deflationary gap)