BY 

SEAN ROSS
 
 Updated Jan 15, 2018
Inflation is and has been a highly debated phenomenon in economics. Even the
use of the word "inflation" has different meanings in different contexts. Many
economists, businessmen, and politicians maintain that moderate inflation levels
are needed to drive consumption--operating under the larger, overarching
assumption that higher levels of spending are crucial for economic growth.
The Federal Reserve typically targets an annual rate of inflation for the United
States, believing that a slowly increasing price level keeps businesses profitable
and prevents consumers from waiting for lower prices before making purchases.
There are some, in fact, who believe that the primary function of inflation is
to prevent deflation.

Others, however, argue that inflation is less important and even a net drag on the
economy. Rising prices make savings harder, driving individuals to engage in
riskier investment strategies to increase or even maintain their wealth. Some
claim that inflation benefits some businesses or individuals at the expense of
most others.

The advantages of inflation

1. Deflation (a fall in prices – negative inflation) is very harmful. When prices are
falling, people are reluctant to spend money because they feel goods will be cheaper in
the future; therefore they keep delaying purchases. Also, deflation increases the real
value of debt and reduces the disposable income of individuals who are struggling to
pay off their debt. When people take on a debt like a mortgage, they generally expect
an inflation rate of 2% to help erode the value of debt over time. If this inflation rate of
2% fails to materialise, their debt burden will be greater than expected. Periods of
deflation caused serious problems for the UK in 1920s, Japan in 1990s and 2000s and
Eurozone in 2010s.

See more Costs of deflation

2. Moderate inflation enables adjustment of wages. It is argued a moderate rate of

inflation makes it easier to adjust relative wages. For example, it may be difficult to cut
nominal wages (workers resent and resist a nominal wage cut). But, if average wages
are rising due to moderate inflation, it is easier to increase the wages of productive
workers; unproductive workers can have their wages frozen – which is effectively a real
wage cut. If we had zero inflation, we could end up with more real wage unemployment,
with firms unable to cut wages to attract workers.
 3. Inflation enables adjustment of relative prices. Similar to the last point, moderate
inflation makes it easier to adjust relative prices. This is particularly important for a
single currency like the Eurozone. Southern European countries like Italy, Spain and
Greece became uncompetitive, leading to large current account deficit. Because Spain
and Greece cannot devalue in the Single Currency, they have to cut relative prices to
regain competitiveness. With very low inflation in Europe, this means they have to cut
prices and cut wages which cause lower growth (due to the effects of deflation). If the
Eurozone had moderate inflation, it would be easier for southern Europe to adjust and
regain competitive without resorting to deflation.

4. Inflation can boost growth. At times of very low inflation, the economy may be
stuck in a recession. Arguably targeting a higher rate of inflation can enable a boost in
economic growth. This view is controversial. Not all economists would support targeting
a higher inflation rate. However, some would target higher inflation, if the economy was
stuck in a prolonged recession. See: Optimal inflation rate

For example, the Eurozone has had a very low inflation rate in 2013-14, and this has
corresponded to very weak economic growth and very high unemployment. If the ECB
had been willing to target higher inflation, then we could have seen a rise in Eurozone
GDP.

Disadvantages of inflation
Inflation is usually considered to be a problem when the inflation rate rises above 2%.
The higher the inflation, the more serious the problem is. In extreme circumstances,
hyper inflation can wipe away people’s savings and cause great instability, e.g.
Germany 1920s, Hungary 1940s, Zimbabwe 2000s. However, in a modern economy,
this kind of hyper inflation is rare. Usually, inflation is accompanied with higher interest
rates, so savers do not see their savings wiped away. However, inflation can still cause
problems.

 Inflationary growth tends to be unsustainable leading to a damaging period

of boom and bust economic cycles. For example, the UK saw high inflation in the late
1980s, but this economic boom was unsustainable, and when the government tried to
reduce inflation, it led to the recession of 1990-92.
 Inflation tends to discourage investment and long-term economic growth. This is
because of the uncertainty and confusion that is more likely to occur during periods of
high inflation. Low inflation is said to encourage greater stability and encourage firms to
take risks and invest.
 Inflation can make an economy uncompetitive. For example, a relatively higher
rate of inflation in Italy can make Italian exports uncompetitive, leading to lower AD, a
current account deficit and lower economic growth. This is particularly important for
countries in the Euro-zone because they can’t devalue to restore competitiveness.
 Reduce the value of savings. Inflation leads to a fall in the value of money. This
makes savers worse off – if inflation is higher than interest rates. High inflation can lead
 to a redistribution of income in society. Often it is pensioners who lose out most from
inflation. This is particularly a problem if inflation is high and interest rates low.
 Menu costs – the cost of changing prices lists becomes more frequent during
high inflation. Not so significant with modern technology.
 Fall in real wages. In some circumstances, high inflation can lead to a fall in real
wages. If inflation is higher than nominal wages, then real incomes fall. This was a
problem in the great recession of 2008-16, with prices rising faster than incomes.

Tejvan Pettinger July 24, 2017  inflation

https://www.economicshelp.org/blog/315/inflation/inflation-advantages-and-disadvantages/

Monetary Measures to Control Inflation

The monetary measures which are widely used to control inflation are:

1. Bank Rate Policy: The bank rate policy is used as an important

instrument to control inflation. The Bank rate, also called as the Central Bank
rediscount rate is the rate at which the central bank buys or redsicounts the
eligible bills of exchange and other commercial papers presented by commercial
banks to build their reserves. Here, the central bank performs the function
as “lender of the last resort”.The bank rate policy as a monetary measure to
control inflation work in two ways:

 During inflation, the central bank raises the interest rates due to which
the borrowing costs go up. As a result, commercial bank borrowings from
the central bank reduces. With the reduced borrowings from the central bank,
the flow of money from the commercial bank to the public also gets reduced.
This is how the bank credit decides the extent to which the inflation is
controlled.
 The bank rate sets the trend for general market interest rate,
specifically in the short-run. As the central bank raises the interest rate with a
view to curtailing the money supply in the market, the commercial banks also
raise their commercial borrowing rates for the public, thereby making the
borrowings dear. Other general market rate follows the suit and with the
decreased borrowing capacity of individual, the inflation is controlled due to
reduced money flows to the society.

2. Variable Reserve Ratio: The variable reserve ratio, also called as

theCash Reserve Ratio (CRR) is a certain proportion of total demand and time
deposits that the commercial banks are required to maintain in the form of cash
reserves with the central bank.
 The cash reserve ratio is often determined and imposed by the central bank with
a view to controlling the money supply. When the central bank raises the CRR,
the lending capacity of the commercial banks reduces due to which the flow of
money from the banks to the public also decreases. Thus, it helps in controlling
the rise in the price to the extent it is caused by the bank credit to the public.

3. Open Market Operations: The open market operations are characterized

by the sale and purchase of government securities and bonds by the
central bank. The central bank buys and sells the government securities and
bonds to the public through commercial banks. The government securities are
sold via commercial banks such that a certain amount of bank deposits is
transferred to the central bank. As a result, the credit creation capacity of the
commercial banks reduces. Thus, the flow of money from the banks to the public
also gets reduced.

Thus, these are the major monetary measures that countries use to keep the
inflationary pressures under control or maintain the desirable limit of inflation.

https://businessjargons.com/monetary-measures-to-control-inflation.html

BY KIMBERLY AMADEO
 
Updated January 28, 2019

Inflation is when the prices of goods and services increase. There are four main
types of inflation, categorized by their speed. They are creeping, walking,
galloping and hyperinflation. There are specific types of asset inflation and also
wage inflation. Some experts say demand-pull and cost-push inflation are two
more types, but they are causes of inflation. So is expansion of the money
supply.

 01

 Creeping Inflation

Bill Pugliano/Getty Images

Creeping or mild inflation is when prices rise 3 percent a year or less. According
to the Federal Reserve, when prices increase 2 percent or less it
benefits economic growth. This kind of mild inflation makes consumers expect
that prices will keep going up. That boosts demand. Consumers buy now to beat
higher future prices. That's how mild inflation drives economic expansion. For
that reason, the Fed sets 2 percent as its target inflation rate.

 02

 Walking Inflation

Jason Greenspan/Getty Images

This type of strong, or pernicious, inflation is between 3-10 percent a year. It is

harmful to the economy because it heats up economic growth too fast. People
start to buy more than they need, just to avoid tomorrow's much higher prices.
This drives demand even further so that suppliers can't keep up. More important,
neither can wages. As a result, common goods and services are priced out of the
reach of most people.

 03

 Galloping Inflation

U.S. National Archives and Records Administration

When inflation rises to 10 percent or more, it wreaks absolute havoc on the

economy. Money loses value so fast that business and employee income can't
keep up with costs and prices. Foreign investors avoid the country, depriving it of
needed capital. The economy becomes unstable, and government leaders lose
credibility. Galloping inflation must be prevented at all costs.
  04

 Hyperinflation

APIC/Getty Images

Hyperinflation is when prices skyrocket more than 50 percent a month. It is very

rare. In fact, most examples of hyperinflation have occurred only when
governments printed money to pay for wars. Examples of hyperinflation
include Germany in the 1920s, Zimbabwe in the 2000s, and Venezuela in the
2010s. The last time America experienced hyperinflation was during its civil war.

 05

 Stagflation

Win McNamee/Getty Images

Stagflation is when economic growth is stagnant but there still is price inflation.

This seems contradictory, if not impossible. Why would prices go up when there
isn't enough demand to stoke economic growth?

It happened in the 1970s when the United States abandoned the gold standard.
Once the dollar's value was no longer tied to gold, it plummeted. At the same
time, the price of gold skyrocketed.

Stagflation didn't end until Federal Reserve Chairman Paul Volcker raised the fed

funds rate to the double-digits. He kept it there long enough to dispel
expectations of further inflation. Because it was such an unusual situation,
stagflation probably won't happen again.

 06
 Core Inflation

Monashee Frantz/Getty Images

The core inflation rate measures rising prices in everything except food and

energy. That's because gas prices tend to escalate every summer. Families use
more gas to go on vacation. Higher gas costs increase the price of food and
anything else that has large transportation costs.

The Federal Reserve uses the core inflation rate to guide it in setting monetary

policy. The Fed doesn't want to adjust interest rates every time gas prices go up.

 07

 Deflation

Mario Tama/Getty Images

Deflation is the opposite of inflation. It's when prices fall. It's caused when an
asset bubble bursts.

That's what happened in housing in 2006. Deflation in housing prices trapped

those who bought their homes in 2005. In fact, the Fed was worried about overall
deflation during the recession. That's because deflation can turn a recession into
a depression. During the Great Depression of 1929, prices dropped 10 percent a
year. Once deflation starts, it is harder to stop than inflation.

 08

 Wage Inflation
Wage inflation is when workers' pay rises faster than the cost of living. This
occurs in three situations. First, is when there is a shortage of workers. Second,
is when labor unions negotiate ever-higher wages. Third is when workers
effectively control their own pay.

A worker shortage occurs whenever unemployment is below 4 percent. Labor

unions negotiated higher pay for auto workers in the 1990s. CEOs effectively
control their own pay by sitting on many corporate boards, especially their own.
All of these situations created wage inflation.

Of course, everyone thinks their wage increases are justified. But higher wages
are one element of cost-push inflation. That can drive up the prices of a
company's goods and services.

 09

 Asset Inflation

Justin Sullivan/Getty Images

An asset bubble, or asset inflation, occurs in one asset class. Good examples

are housing, oil and gold. It is often overlooked by the Federal Reserve and other
inflation-watchers when the overall rate of inflation is low. But the subprime
mortgage crisis and subsequent global financial crisis demonstrated how
damaging unchecked asset inflation can be.

 10

 Asset Inflation -- Gas

Inflation in gas prices affect people dramatically. (Photo: Mark Renders/Getty
Images)

Gas prices rise each spring in anticipation of the summertime vacation driving

season. In fact, you can expect gas prices to rise ten cents per gallon each
spring. But political uncertainty in the oil-exporting countries drove gas prices
higher in 2011 and 2012. Prices hit an all-time peak of $4.11 in July 2008, thanks
to economic uncertainty. 

What do oil prices have to do with gas prices? A lot. In fact, oil prices are
responsible for 72 percent of gas prices. The rest is distribution and taxes. They
aren't as volatile as oil prices. 

 11

 Asset Inflation -- Oil

 David McNew/Getty Images

Crude oil prices hit an all-time high of $143.68 a barrel in July 2008. This was in
spite of a decrease in global demand and an increase in supply. Oil prices are
determined by commodities traders. That includes both speculators and
corporate traders hedging their risks. Traders bid up crude oil prices in two
situations. First, is if they think there are threats to supply, such as unrest in the
Middle East. Second, is if they see an uptick in demand, such as growth in
China.

 12

 Asset Inflation -- Food

  Elly Lange/ Getty Images

Food prices soared 6.8 percent in 2008, causing food riots in India and

other emerging markets. They spiked again in 2011, rising 4.8 percent. High food
costs led to the Arab Spring, according to many economists. Food riots caused
by inflation in this important asset class could reoccur.

 13

 Asset Inflation -- Gold

David McNew/Getty Images

An asset bubble occurred when gold priceshit the all-time high of $1,895 an

ounce on September 5, 2011. Although many investors might not call this
inflation, it sure was. That's because prices rose without a corresponding shift in
gold's supply or demand. Instead, investors ran to gold as a safe haven. They
were concerned about the declining dollar. They felt gold protected them from
hyperinflation in U.S. goods and services. They were uncertain about global
stability.

Inflation affects everything around us, from basic necessities like housing, food,
medical care and utilities to the cost of cosmetics and new automobiles.
Furthermore, inflation can effortlessly deteriorate our savings. It makes the
money saved today less valuable tomorrow, eroding our future purchasing power
and even interfering with our ability to retire. 

Central banks monitor inflation closely, as it is the overriding force behind

monetary policies. These are the monetary policies that impact the level of
money supply and the availability of credit within an economy. Central banks of
developed economies, including the Federal Reserve in the United States,
generally aim to keep the inflation rate around 2%. In this article, we will examine
the fundamental factors behind inflation, different types of inflation and who
benefits from it.
Causes of Inflation
Consumer Confidence: When unemployment is low and wages are stable,
consumers are more confident and more likely to spend money. This
confidence drives up prices as manufacturers and providers charge more for
goods and services that are in high demand. One example is the market for new
housing. In a booming economy, people purchase more new houses.
Contractors experience greater demand for their services, and they raise their
prices to capitalize on that demand. Similarly, the building materials included in
the houses also cost more as supplies dwindle and consumers increase what
they are willing to pay to complete the project. (For related reading, see: How
Inflation and Unemployment Are Related.)

Decreases in Supply: One of the basic causes of inflation is the economic

principle of supply and demand. As demand for a particular good or service
increases, the available supply decreases. When fewer items are available,
consumers are willing to pay more to obtain the item. Supply decreases for
several reasons. Oftentimes a natural disaster or environmental effect is at fault
for a supply-chain interruption, such as when a tornado destroys a factory or a
severe drought kills crops. Supplies also decrease when an item is immensely
popular, a phenomenon that frequently is seen when new cellphones or video
games are released.

Corporate Decisions: Sometimes inflation happens naturally as supplies

decrease and demand increases, but other times it is orchestrated by
corporations. Companies that make popular items frequently raise prices simply
because consumers are willing to pay the increased amount. Corporations also
raise prices freely when the item for sale is something consumers need for
everyday existence, such as oil and gas.

Decisions made by business owners can cause inflation even when it wasn't the
intended effect. Farmers often decide to thin their cattle herds when the price of
feed increases. That decision saves the farmers money, but it means that less
beef is available for sale, driving up the price and sparking inflation. (For related
reading, see: Inflation's Impact on Stock Returns.)

How Inflation Rates Are Determined

The inflation rate is determined by the rate of change in a price index. The most
cited and analyzed price index in the United States is the Consumer Price Index
for All Urban Consumers (CPI-U), which is released by the Bureau of Labor
Statistics each month . The Consumer Price Index for All Urban Consumers is a
weighted basket of goods and services, ranging from food and beverage to
education and recreation. A second, often-quoted price index is the producer
price index (PPI), which includes things like fuels and farm products (meats and
grains), chemical products and metals. The producer price index reports the price
changes that affect domestic producers, and you can often see these prices
changes being passed on to the consumers some time later in the Consumer
Price Index. 

Types of Inflation
Cost-Push Inflation
Cost-push inflation is one of two main types of inflation within an economy. It
refers to rising costs of production (usually in the form of wages) contributing to
increasing pricing pressure. One of the signs of possible cost-push inflation can
be seen in rising commodity prices, as commodities like oil and metals are major
production inputs. 

Wages also affect the cost of production as the single biggest expense for
businesses. Analysts and policy makers currently see the labor market, through
the unemployment rate, as the most important production input. As shortages in
labor can create pressure to raise wages, it flows naturally that the lower the
unemployment rate, the higher the possibility of labor shortages. 

Demand-Pull Inflation
While cost-push inflation is a supply-side issue, demand-pull inflation occurs
when high demand causes rising prices. Demand-pull inflation can be caused by
factors such as the following:

 Expansionary fiscal policy. By lowering taxes, governments can increase

the amount of discretionary income for both business and consumers.
Businesses may spend it on capital improvements, employee
compensation or new hiring, among other things. Consumers may
purchase more nonessential items. Furthermore, as the government
stimulates the economy by increasing its spending, say by undertaking
major infrastructure projects, the demand for goods and services will
increase, leading to price increases.
 Devaluation of the currency. Currency devaluation can lead to higher
exports (as our goods become suddenly less expensive and thus more
attractive to foreign buyers) and this increases aggregate demand for our
goods and services. Higher demand can lead to high prices. Currency
devaluation can also result in lower imports (as foreign goods become
suddenly more expensive to purchase with devalued dollars). 
 Expansionary monetary policy. Through open market operations, central
banks can increase the money supply and create a surplus of liquidity that
can bring down the value of money vis-à-vis the price of goods. In other
words, by expanding the money supply, the purchasing power of all the
participants in an economy increases, leading to a rise in aggregate
 demand. If the supply of goods do not adjust with this excess demand,
then there will upwards pressure on prices. (See also: Cost-Push Inflation
Versus Demand-Pull Inflation.)

Inflationary Expectations
Once inflation becomes prevalent enough in an economy, the expectation of
further inflation becomes an overriding concern in the consciousness of
consumers and businesses alike. These expectations then become a guiding
principle behind the actions of these economic agents, causing inflation to persist
in an economy long after the initial shock has dissipated.

https://www.investopedia.com/ask/answers/111314/what-causes-inflation-and-does-anyone-gain-
it.asp JAN 22 2018 BY INVESTOPEDIA

Historically, rapid increases in the quantity of money or in the overall money supply have occurred in
many different societies throughout history, changing with different forms of money used.[16][17] For
instance, when gold was used as currency, the government could collect gold coins, melt them
down, mix them with other metals such as silver, copper, or lead, and reissue them at the
same nominal value. By diluting the gold with other metals, the government could issue more coins
without increasing the amount of gold used to make them. When the cost of each coin is lowered in
this way, the government profits from an increase in seigniorage.[18] This practice would increase the
money supply but at the same time the relative value of each coin would be lowered. As the relative
value of the coins becomes lower, consumers would need to give more coins in exchange for the
same goods and services as before. These goods and services would experience a price increase
as the value of each coin is reduced.[19]

Conceptually, inflation refers to the general trend of prices, not changes in any specific price. For
example, if people choose to buy more cucumbers than tomatoes, cucumbers consequently become
more expensive and tomatoes cheaper. These changes are not related to inflation; they reflect a
shift in tastes. Inflation is related to the value of currency itself. When currency was linked with gold,
if new gold deposits were found, the price of gold and the value of currency would fall, and
consequently prices of all other goods would become higher.[34]

A Consumer Price Index measures changes in the price level of market basket of consumer

goods and services purchased by households.
The CPI is a statistical estimate constructed using the prices of a sample of representative items
whose prices are collected periodically. Sub-indices and sub-sub-indices are computed for different
categories and sub-categories of goods and services, being combined to produce the overall index
with weights reflecting their shares in the total of the consumer expenditures covered by the index. It
is one of several price indices calculated by most national statistical agencies. The annual
percentage change in a CPI is used as a measure of inflation. A CPI can be used to index (i.e.
adjust for the effect of inflation) the real value of wages, salaries, and pensions; to regulate prices;
and to deflate monetary magnitudes to show changes in real values. In most countries, the CPI,
along with the population census, is one of the most closely watched national economic statistics.

Inflation compared to federal funds rate

A graph of the US CPI from 1913 (in blue), and its percentage annual change (in red)

The index is usually computed monthly, or quarterly in some countries, as a weighted average of
sub-indices for different components of consumer expenditure, such as food, housing, shoes,
clothing, each of which is in turn a weighted average of sub-sub-indices. At the most detailed level,
the elementary aggregate level, (for example, men's shirts sold in department stores in San
Francisco), detailed weighting information is unavailable, so indices are computed using an
unweighted arithmetic or geometric mean of the prices of the sampled product offers. (However, the
growing use of scanner data is gradually making weighting information available even at the most
detailed level.) These indices compare prices each month with prices in the price-reference month.
The weights used to combine them into the higher-level aggregates, and then into the overall index,
relate to the estimated expenditures during a preceding whole year of the consumers covered by the
index on the products within its scope in the area covered. Thus the index is a fixed-weight index,
but rarely a true Laspeyres index, since the weight-reference period of a year and the price-
reference period, usually a more recent single month, do not coincide.
Ideally, the weights would relate to the composition of expenditure during the time between the
price-reference month and the current month. There is a large technical economics literature
on index formulas which would approximate this and which can be shown to approximate what
economic theorists call a true cost-of-living index. Such an index would show how consumer
expenditure would have to move to compensate for price changes so as to allow consumers to
maintain a constant standard of living. Approximations can only be computed retrospectively,
whereas the index has to appear monthly and, preferably, quite soon. Nevertheless, in some
countries, notably in the United States and Sweden, the philosophy of the index is that it is inspired
by and approximates the notion of a true cost of living (constant utility) index, whereas in most of
Europe it is regarded more pragmatically.
The coverage of the index may be limited. Consumers' expenditure abroad is usually excluded;
visitors' expenditure within the country may be excluded in principle if not in practice; the rural
population may or may not be included; certain groups such as the very rich or the very poor may be
excluded. Saving and investment are always excluded, though the prices paid for financial services
provided by financial intermediaries may be included along with insurance.
The index reference period, usually called the base year, often differs both from the weight-reference
period and the price-reference period. This is just a matter of rescaling the whole time-series to
make the value for the index reference-period equal to 100. Annually revised weights are a desirable
but expensive feature of an index, for the older the weights the greater is the divergence between
the current expenditure pattern and that of the weight reference-period.
https://en.wikipedia.org/wiki/Consumer_price_index

Causes[edit]
Historically, a great deal of economic literature was concerned with the question of what causes
inflation and what effect it has. There were different schools of thought as to the causes of inflation.
Most can be divided into two broad areas: quality theories of inflation and quantity theories of
inflation.
The quality theory of inflation rests on the expectation of a seller accepting currency to be able to
exchange that currency at a later time for goods that are desirable as a buyer. The quantity theory of
inflation rests on the quantity equation of money that relates the money supply, its velocity, and the
nominal value of exchanges.
Currently, the quantity theory of money is widely accepted as an accurate model of inflation in the
long run. Consequently, there is now broad agreement among economists that in the long run, the
inflation rate is essentially dependent on the growth rate of the money supply relative to the growth
of the economy. However, in the short and medium term inflation may be affected by supply and
demand pressures in the economy, and influenced by the relative elasticity of wages, prices and
interest rates.[42]
The question of whether the short-term effects last long enough to be important is the central topic of
debate between monetarist and Keynesian economists. In monetarism prices and wages adjust
quickly enough to make other factors merely marginal behavior on a general trend-line. In
the Keynesian view, prices and wages adjust at different rates, and these differences have enough
effects on real output to be "long term" in the view of people in an economy.