PRICE STABILITY

INFLATION
MEANING,CAUSES and
ECONOMIC IMPACTS
 INFLATION
• Increase in the ‘general price level’ sustained
over a period of time
• Measured for a basket of goods and services
• Overall rise in price, persistent rise
• TYPES :
(v) Creeping Inflation – increase single digit
(vi) Galloping Inflation – double or triple digits
(iii) Hyper Inflation --very large and accelerating
 Main Causes
• Excess of Money Supply
• Deficit financing
• Rise in Demand for goods and services
• Supply rigidities, bottlenecks, structural imbalances
Demand Pull Factors:
 Continuous rise in govt. expenditure
 Shortage of goods in proportion to demand
 Extensive hoarding and Speculation of
essential goods
 Unaccounted money
 Pressure of growing Population
Cost Push Factors:
 Monopolistic actions of some firms
 Labor Unions , rise in wage level, imperfect labor market
 Managers of Private Firms
 Public Sector Undertakings
 Violent Fluctuations in Output
 Upward revision of administered prices
 Oil shocks and Global inflation
 Rising prices of Imports, ban on imports
 Heavy taxation of common goods
 Indirect Taxation
 Domestic price level
 Failure of the govt. policy
 The Economic Impacts of Inflation
I. On Income and Wealth Distribution
 Redistributive effect on the real value of
people’s wealth
-- Unanticipated inflation redistributes from
creditors to debtors
-- unanticipated decline has the opposite
effect
-- Random redistribution of wealth with little
significance on any single group
II. On Economic Efficiency
--- Distorts price signals
--- high inflation –distinction difficult between
changes in relative prices and overall price
-- Distorts the use of money
increase in rate of inflation – decrease in real
rate of interest
Cash management schemes in favor of real
sources at the expense of valuable Consumption
and Investment.
III. On Taxes
-- more significant inflation increases tax rates with
increase in income distorting measurement of
Income
IV. On the entire Economy
-- new price decisions
-- Budget not in line with inflation
-- Request for rise in prices by Industries
-- decline in real benefits
-- People’s income affected in a number of ways
 PHILLIP”S CURVE
Two important Variables receiving attention in
Macroeconomics
-Unemployment and Inflation
Pioneer on the relation between Rate of
unemployment and rate of wage increase
British Economist- A.W.Phillips
After a study on a century’s link between the two –
inverse relationship
Modified version- Rate of Unemployment and
Rate of Inflation
Increase in growth rate of wages not matched by
equal increase in the growth rate of labor
productivity- converted into increase in the
inflation rate. eg.
Increase in money wage rate-5%/yr
Increase in labor productivity -2%/yr
Rate of inflation - 3%/yr
Low unemployment and tight labor market
Indicative of buoyant d for goods and abundant
profits –demand for excessive wage increase
will be granted.
Phillip’s Curve
Trade-Off between Inflation andUnemploymt
Existed in 1960’s – 1970’s – Stagflation
Relevance of Phillip’s Curve only in the
short run and in the long run P.C. –Vertical
 Long Run Phillip’s Curve
• Natural Rate of Unemployment-above
which inflation rate tends to increase and
below which IR decreases.At N.R. –
neither the tendency for an acceleration or
deceleration in the rate of inflation.
This is the rate of unemployment at which
Actual rate of inflation is equal to the
expected rate of inflation. Long run PC
positioned at NU.
 Phillip’s Curve in the Long Run

I3

I2
PC3
I1
PC2
PPC1
P
U C
U C
U2
U1
UU UN
U
uU U
UU N
• If expected rate of inflation is less than the
actual rate expansionary policy can
reduce the volume of unemployment in
the short run U2 the revision in the policy
the position is back to NU. If the expected
rate of inflation is higher than the actual
,PC moves up and the Unemployment rate
isU3 temporarily.In the long run no trade
off between rate of inflation and rate of
unemployment