Types of Inflation - Essay Example

Ali Al-Ansari Inflation Spring ECO 201,004 Dr. Martin Sabo Inflation Inflation is a steady ad stable trend of growth in the overall price level. Here stable means that inflation is a lengthy process and a stable trend and therefore it should be distinguished from the surge. The general price level inflation does not mean growth of all prices in the economy. Prices for different products may behave differently such as rise, drop, remains unchanged. It is important to increase the overall price index that is the GDP deflator. There is also the concept of disinflation that means reducing the rate of inflation. Some of the main objectives of macroeconomics are to achieve high sustainable rate of economic growth in any economic system (Joudaki, Sadrabadi and Sarlak, 190). But inflation have quite negative effects on the economic activities. All types of inflation are complex, diverse and have very significant economic and social implications for all economic entities. Small inflation contributes to higher prices and profit margins keeping in mind the time factor revitalizing environment. With the development of inflation, it turns into a serious obstacle to reproduction, exacerbating economic and social tensions in society. Galloping inflation causes serious economic damages to both large corporations and small businesses, primarily due to the uncertainty of market conditions. Uneven growth of prices increases the disparity between the sectors of the economy and distorts the structure of consumer demand. Inflation activates flight from money to goods, turning this process in an avalanche; trade exacerbates hunger that undermines incentives to cash accumulation, disrupts the functioning of the monetary system and revives barter. The inflation is calculated as a percentage of the difference in the general price level of the current year with the general price level the previous year. Thus, the inflation rate is not only characterized by the growth rate of the general price level. Moderate inflation, as measured by percent per year and the level of which is up to 10 % per year. Inflation at 3 - 4% per year is assumed normal for a modern economy and it is also considered an incentive to increase output and is known as the natural rate of inflation (natural rate of inflation). High inflation is measured by percent per month, can go up to 200 - 300 percent or more per year and is observed in many developing countries and countries with economies in transition. On the other hand, hyperinflation is also measured in percent usually on weekly basis and the level of which is 40 - 50 % per month, or more than 1000 % per year. Classic examples are the situation of hyperinflation in Germany was observed in January 1922 to December 1924 , when the growth rate of prices were 10 , 12 and in Hungary (August 1945 - July 1946 ) , when the price level for the year rose to 3.8 x 10.27 times with average growth of 198 times. Causes of inflation Inflation demand (demand pull inflation) occurs because of the increase in aggregate demand. Growth of aggregate demand and can be caused by either an increase in any of the components of total expenditures (consumer, investment, government and net exports), or increasing level of the money supply. The main reason for inflation according to most of the economists is the increase in the money supply. The high rate of growth of money supply (money issue) required to finance the state budget deficit, which arises from the fact that government spending significantly exceed its revenues is the main cause of high inflation observed in developing countries and countries with economies in transition. In these countries the issue of money is, in fact, the only possible way to finance the budget deficit, as other sources of funding such as internal and external borrowings are limited and sometimes unavailable. Cost inflation is caused by the reduction of aggregate supply that occurs as a result of rising costs. Cost inflation leads to stagflation which is a simultaneous decline in production and an increase in the price level. Effects of inflation The list of people that are affected by inflation encompasses people with fixed income such as government employees, retirees, students, etc. and the people who are benefited by this phenomenon of inflation are Investors, lenders, the borrowers and the governments because more money in circulation increases the tax base and thus tax revenues grow. Inflation is a consequence of the loss of purchasing power of money. Purchasing power of money is the amount of goods and services, which can be purchased at one monetary unit. If the prices are rising, the purchasing power of money falls. The most serious and devastating consequence of hyperinflation is the collapse of the financial system (money ceases to have value because their purchasing power is falling rapidly) Another major reason of inflation is the increase in social tensions that may result in political shocks, military coups, civil wars, revolutions and etc. Cause of hyperinflation includes a huge increase in the money supply (money issue) to finance government expenditures, whether associated with wars, or to the inability to finance the large budget deficit cited by other means. Inflationary spiral is the result of combination of unforeseen demand inflation and cost inflation. The mechanism of inflationary spiral can be explained as, if the central bank unexpectedly increases the money supply, this will lead to an increase in aggregate demand and which will result in causing inflation of demand, resulting in the growth of the price level. Since the wage rate remains the same, real incomes fall. The workers demand higher wages in proportion to the growth of the price level. This increases the costs of firms and leads to a reduction of the aggregate offers, generating cost inflation, which results in the price level increase. Real time income will reduce again. Working again with demand on higher nominal wages is like its height is working normally as first perceived as higher real wages and consumer spending are increasing, causing inflation of demand , which is combined with cost inflation due to the increase in nominal wages. This causes an even greater increase in the level of prices. Falling real incomes again, leads to higher wage demands, and all over again. All this movement is spiral and therefore, this process is called an inflationary spiral. The rise in prices provokes higher wages, and wage growth is the basis for the increase in price level. Economic Growth Economic growth is a long-term upward trend in real GNP. The main goal of economic growth is the growth of welfare and increase in national wealth. The more productive potential of the country and the higher rates of economic growth gives the higher the level and quality of life. Impact of inflation on various economic processes Impact of inflation on capital formation Inflation is the main reason behind the decline of capital formation. In the early stages of inflation depreciation of contributions margins and the higher inflation rate results in fact that fewer goods and services can be purchased with the money held on deposit. While the interest rate on deposits is higher than the rate of price growth, yield savings persists. Savings income gradually declines. When the interest rate becomes negative that is less than the growth rate of prices, savings lose their meaning. The impact of inflation on economic growth Keynesian followers believe that the weak inflation stimulates economic development. With slow rate at constant price, it increases additional profit in the firms. Accordingly, they will be interested in investing and expanding production areas. While the rise in prices will be relatively small, and the economy will be having unused resources and this process will continue. Effects of inflation 1) Latent state confiscation of funds through taxes 2) Redistribution of income and wealth - Any domestic loan, in an inflationary environment , when returned after a period of time at par and fully compensated but still it actually returns much less. This is due to the fact that over time the national volute gradually depreciates. 3) The lag in prices of public enterprises from the market - In the private sector market economy production costs and prices of goods are revised more frequently and more rapidly than in the state sector. This process is long and inefficient, and in terms of timeliness it is sudden, unexpected and abrupt which causes rise in inflation and even technically difficult to implement. As a result, it increases the imbalance of the private and public sectors. This effect is particularly dangerous, as the state loses its economic potential impact on the market. 4) Causes inversely proportional rate of inflation and unemployment 5) Fall in real interest 6) The instability of economic information 7) One of the consequences of unbalanced inflation is fast materialization of funds - Citizens and corporations seek to materialize their rapidly depreciating cash reserves. People buy antiques, jewellery, appliances, etc. Companies are developing plans to enhance the use of cash resources. Conclusion The low inflation rate may not affect the economic operations significantly but the high rate of inflation impacts the economic activities in a highly negative manner. The effect is found to be quite powerful and statistically significant. One of the main reasons of inflation is the lack in the coordination between the rate of increase of money in the society and the increase in the rate of production Work Cited Joudaki, Hojat Allah, Mohammad Hossein Hassani Sadrabadi, and Ahmad Sarlak. "CAUSAL RELATIONSHIP BETWEEN INFLATION AND ECONOMIC GROWTH IN IRAN DURING THE YEARS 1978-2011." Sattarov, Khayroollo. "Inflation and Economic Growth." (2011). Li, Min. "Inflation and economic growth: Threshold effects and transmission mechanisms." Department of Economics, University of Alberta (2006): 8-14. Faria, Joao Ricardo, and Francisco Galrao Carneiro. "Does high inflation affect growth in the long and short run?." Journal of Applied Economics 4.1 (2001): 89-105. Fountas, Stilianos, Menelaos Karanasos, and Jinki Kim. "Inflation uncertainty, output growth uncertainty and macroeconomic performance." Oxford Bulletin of Economics and Statistics 68.3 (2006): 319-343. Read More