Types of Inflation & its Basics

There are two theories in the economics that are generally accepted as the causes of inflation.

• Demand pull inflation – Happens when too much Money chases too few Goods.

This situation mostly exists in a Growing economy (Like India), where there are huge expansions from the Government and Private Sector, leading to increase in employment, which in turn will increase the purchasing power of the consumer.

This leads to an environment, where people have got too much money to buy goods and/or services, but the supply of goods and services are not growing at the same rate, resulting in a supply and demand mismatch. To adjust this, producers will increase the price of goods.

• Cost push inflation – Happens when the aggregate cost of resources goes up, for the companies due to decrease in supply or increase in taxes. This situation primarily exists in Developed Economies such as US or UK.

Companies pass this increase on to consumers in the form of increased prices. For example, Crude oil prices have gone up sharply in past few months on account of decrease in supply. The economy sectors where oil is the part of their cost element, will pass on this increase to customers by increasing prices of their goods and services.

It is not necessary that only one type of inflation exists in an economy at a time. They can co-exist.

For instance, in India right now we have both types of Inflation, Oil and Metal prices have gone up to record highs, giving rise to Cost Push Inflation. At the same time, purchasing power has also increased due to increases in employment, wages, and easy availability of money, creating Demand Pull Inflation. This combined effect has taking inflation to the 13-year high that we are experiencing right now.

Inflation is not always an Evil.

Within limits, Inflation is required for an Economy to grow. It’s very well said that inflation is the sign of a growing economy. Imagine an environment where there is no price increase; in fact prices are falling (this situation is opposite of inflation known as deflation). There will be no increase in wages. Nobody would like to have that environment.

But when inflation is too high it adversely affect the consumer and the economic conditions of the nation as well:

• In a fixed interest rate environment the Creditor will lose money, if he has not properly estimated the inflation and accordingly fixes the interest rate. High inflation can sometime result in negative real interest rates. This can be currently seen in India as the inflation is touching 11.4% and the interest rate on fixed deposit is 9% it is actually giving negative return of 2.4%
• It decreases the savings of the individuals. As the prices increase, the consumer has to shell out more money from his pocket to buy the same products but his income has not increased. Therefore he has to eat up his savings.
• As savings get reduced, automatically investments will reduce, affecting the economy negatively.
• If the inflation in one country is greater than another, the products and services of the former will become less competitive due to the increase in its prices.

To control inflation Central Banks, take Monetary actions and government takes fiscal measures. But individuals should also take some steps to get over it. They should invest their money in the investment avenues which gives better return, should try to minimize unwanted expenses, reduce the consumption of the commodity that has become very expensive, and find out some substitute that will help them in managing their own inflation.

Additions, Suggestions for Improvement & your feedback is always welcome.

Hope this article helps you in some way.