What is Inflation?
Inflation or price inflation is a rise in the price level in an economy which results in a sudden drop in the purchasing power of money. It is a loss of real value in the medium of exchange. The measure of inflation is the inflation rate and is measured in percentage. The purchasing power of currency decreases as goods and services become dearer. This impacts the cost of living and gets higher. However, a certain level of inflation is required in the economy
Types of Inflation
There are different types of inflation to get an analysis of distributional and other effects of inflation. There are mainly four types of inflation. Experts say that demand-pull and cost-push are more two types of inflation not yet categorized. There are various other types of inflation like asset inflation and wage inflation. The main types of inflation are listed below by their speed levels namely:
On The Basis of Speed and Intensity
1. Creeping
Creeping inflation is when the price rise is 3% or lower and is scheduled to rise in all coming years. This type of inflation is beneficial for the economy as it promotes demand among consumers. According to The Federal Reserve, the price rise of 2% or less benefits the economy. The consumers are prepared for the price rise and hence buy the product now to beat future higher prices.
2. Walking
This inflation is between 3 to 10% a year. This is harmful to the economy as it heats up the cycle. People are willing to buy more and more to beat future high prices which affect supply as well. Suppliers can’t keep up the supply drive among people.
3. Galloping
This inflation rises to 10% or more and is absolute havoc to the economy. Money loses its value very fast and businesses can’t keep up with cost and prices. Investors avoid the country, the government loses its credibility, and the economy becomes unstable. This inflation at any cost should be avoided at any cost.
4. Hyperinflation
It is when prices skyrocket more than 50% a month and this situation is infrequent. This usually happens when the government prints money to pay for wars.
On The Basis of Causes
1. Currency Inflation
It is caused by the printing of currency notes.
2. Credit Inflation
Commercial banks sanction loans and advances to people in large numbers when the economy needs. This situation leads to rising in the price level
3. Deficit-induced Inflation
When expenditure exceeds revenue, the budget of the government reflects a deficit. To meet the gap, the government may ask the central bank to print additional money. Any price rise during this period is called deficit-induced inflation.
4. Demand-pull Inflation -
An increase in demand over available output leads to this type of inflation and leads to a rise in price.
5. Cost-push Inflation -
Inflation may arise from an overall increase in the cost of production. The cost of production rises from an increase in the prices of raw material, wages, etc.
The above part was a brief discussion on inflation, types and causes of inflation, and how it affects the overall economy. How consumers and producers play their role when prices rise.
Inflation is contrasted by deflation, where the purchasing power of money is increased and prices of commodity decrease
How is Inflation Measured?
The well-known indicator of inflation is the Consumer Price Index (CPI), which measures the percentage change in the prices.
For example, We calculate inflation for a basket that has two items in it - books and childcare. The formula for calculating inflation is as below:
Inflation = Price ( year 2) - Price ( year 1 ) / Price ( year 1 ) * 100
This has certain limitations as well. These are discussed in below pointers:
CPI is not an indicator of the price level. It measures the rate of change of price but not the price level.
Quality changes over time of the products. CPI intends to only calculate pure price changes.
CPI measures price changes in metropolitan cities and does not cover regional, rural, or remote areas.
CPI does not often adjust for changes in the household spending pattern.
CPI does not immediately introduce new product prices as soon as the product is introduced in the market.
CPI does not measure the cost of living. Although it is used to measure the same but is not often categorized as an ideal indicator.
Pros and Cons of Inflation
Inflation is taken as both positive as well as negative depending upon which side one takes and how constructively the situation gets managed.
For example, People owning tangible assets would want to sell their assets as they will get a higher price for the same. This will not go accordingly with the buyer as they would not want to buy the assets at a higher price.
Pros:
It enables growth
Allows adjustment of wages
It allows adjustment of prices
Cons:
It creates uncertainty and lowers investment.
Leads to lower growth and instability
Reduces international competitiveness
Leads to recession
Fall in value of savings.
FAQs on Forms of Inflation: Causes and Types
1. What is inflation and how is it primarily measured?
Inflation is the rate at which the general level of prices for goods and services is rising, leading to a fall in the purchasing power of currency. In India, it is primarily measured using the Consumer Price Index (CPI), which tracks the average change in prices paid by consumers for a standard basket of goods and services.
2. What are the main types of inflation when classified by their cause?
Based on their underlying causes, the two principal types of inflation are:
- Demand-Pull Inflation: Occurs when the total demand for goods and services in an economy exceeds the total supply. This is often described as “too much money chasing too few goods.”
- Cost-Push Inflation: Occurs due to an increase in the costs of production, such as wages or raw materials. Producers pass these higher costs to consumers in the form of higher prices.
3. How is inflation classified based on its rate or speed?
Inflation can be classified into four main categories based on its speed:
- Creeping Inflation: A slow and predictable price rise, typically 2-3% annually, which is often considered healthy for economic growth.
- Walking Inflation: A moderate price rise, usually between 3-10% annually, that can be a warning sign if not controlled.
- Galloping Inflation: A very high rate of inflation, rising to double or triple digits, which can destabilise an economy.
- Hyperinflation: An extreme and out-of-control form of inflation where prices can increase by more than 50% per month.
4. What is demand-pull inflation and what are some of its common causes?
Demand-pull inflation arises when aggregate demand in an economy outpaces aggregate supply. This imbalance leads to a rise in the general price level. Common causes include:
- Increased government spending.
- A reduction in income or corporate taxes, leading to higher disposable income.
- Rapid growth in the money supply due to expansionary monetary policy.
- A sudden boom in exports increasing foreign demand.
5. What are the primary factors that lead to cost-push inflation?
Cost-push inflation is triggered by an increase in the cost of production, independent of demand. The primary factors include:
- Wage-push: An increase in wages that is not matched by a rise in productivity.
- Profit-push: When firms with monopoly power increase prices to raise their profit margins.
- Supply shocks: An increase in the prices of key raw materials, like oil, or disruptions in the supply chain.
6. Is inflation always considered harmful to an economy?
No, a low and stable level of inflation is often considered beneficial. Creeping inflation (around 2-3%) can encourage spending and investment, as consumers and businesses expect prices to rise slightly. It also makes it easier for wages and prices to adjust. However, high and volatile inflation is harmful as it erodes savings, creates economic uncertainty, reduces international competitiveness, and can lead to a recession.
7. How does the impact of cost-push inflation differ from demand-pull inflation on national output and employment?
The two types of inflation have very different effects. Demand-pull inflation is typically associated with a booming economy where output is high and unemployment is low. In contrast, cost-push inflation is often accompanied by a fall in output and a rise in unemployment. This is because the higher costs of production force businesses to reduce their scale of operations, leading to a phenomenon known as stagflation (stagnant growth plus inflation).
8. Why might a country's central bank tolerate or even aim for a low level of 'creeping inflation'?
Central banks often aim for a low, positive rate of inflation for several strategic reasons. A small amount of inflation helps to avoid the risks of deflation (falling prices), which can discourage spending and lead to economic stagnation. It also provides a buffer, allowing real wages to adjust downwards if necessary without cutting nominal wages, a concept that helps 'grease the wheels' of the labour market.
9. What is the key difference between inflation, deflation, and stagflation?
These three economic conditions are distinct:
- Inflation refers to a sustained increase in the general price level of goods and services.
- Deflation is the opposite; it's a sustained decrease in the general price level, where money becomes more valuable.
- Stagflation is a particularly difficult scenario where the economy experiences high inflation, high unemployment, and stagnant economic growth simultaneously.
10. As per the CBSE Class 12 syllabus for the 2025-26 session, what are the primary monetary measures to control high inflation?
To control high inflation (a situation of excess demand), a central bank like the RBI uses its monetary policy tools. The primary measures include:
- Increasing the Repo Rate: Makes borrowing more expensive for commercial banks, which in turn reduces the money supply.
- Selling Government Securities: Through Open Market Operations (OMO), the central bank sells securities to absorb excess money from the market.
- Increasing Reserve Ratios: Raising the Cash Reserve Ratio (CRR) or Statutory Liquidity Ratio (SLR) reduces the funds commercial banks have available for lending.
