Inflation is a persistent tendency for the prices of most goods and services to rise over time. Inflation has been a worldwide problem throughout much of the 20th century. Nonetheless, inflation has proved to be extremely difficult for economists to define or to distinguish from related problems. How, for example, are we to differentiate between inflation, on the one hand, and changes in relative prices, on the other?
If, at some point, the cost of a pair of shoes were to rise compared to other products, this would ordinarily be considered as change in relative prices, a once and for all change in the cost of one item compared to other products, not inflation. Suppose, however, that the cost of shoes were to rise continuously for some time. This persistent price rise might indeed be inflationary, yet because shoes are not a major element in most economies it would also not be very significant. Now suppose that the price of coal were to rise continuously (Wilson, 2001).
Coal, of course, is used in many different industrial processes and as a result the cost of all goods so produced might also therefore trigger off serious inflation in the economy as a whole. But how much time must elapse before higher prices are regarded as inflationary? Unfortunately, the answer can vary. Moreover, inflation in the cost of particular products, over however long a period, is not the only cause of inflation. Persistent price rises can also stem from factors (like increases in the money supply and deficits in the government budget) whose effects are diffused throughout the economy.
Thus it is often hard to determine whether a rise in the price of one product is part of an inflationary trend in the economy as a whole or simply reflects consumers’ willingness, at some point, to spend more of their incomes on that particular product. The distinction between relative price changes and persistent general price increases—or inflation—becomes even more blurred in the case of open economies, those with an extensive network of trading links with the rest of the world. Some economies are clearly more open than others (Ball, 2001).
Thesis Statement: This paper intend to: (1) provide the readers an understanding of inflation; (2) give the causes and effects to our economy and to the industries; (3) aware the readers on how to control inflation. II. Discussion A. Causes of Inflation The causes of inflation are complex and the subject of much debate among economists. What follows is a simplified, general explanation. Excessive Money Supply. Inflation occurs when the amount of money available for spending increases more rapidly than the supply of goods and services.
The supply of money includes paper money, coins, and checking-account and other demand deposits in banks. This supply can be expanded by increased borrowing through banks on the part of government and industry; by extending easy credit to consumers and encouraging instalment buying; and by the printing of more money. These practices will lead to inflation if the supply of goods and services fails to increase at the same pace as the money supply (Ball, 2004). A common cause of such a situation is war. If time of war, government expenditures increase greatly.
Industry must employ more workers to manufacture arms, usually causing a labor shortage and leading to higher wages. Borrowing by government and industry also greatly increases. All of this injects more money into the economy, causing people to compete for what goods are available, driving up prices (Ball, 2004). Government spending in peacetime can also cause inflation. Transfer payments—expenditures, such as those for Social Security or welfare, made to individuals for purposes other than procuring goods and services—increase the amount of cash in the economy, and may lead to excess demand for goods, thus raising prices.
The government’s own purchase of goods and services may put excess demand on the economy and trigger inflation (Christiano, 2003). The type of inflation discussed thus far is sometimes called demand-pull, because the demand for products pulls prices up. Sometimes, however, products are not directly involved. A nation exhausted by war, short of natural resources and investment funds, or suffering serious unemployment or other economic ills, may deliberately increase the money supply—usually by simply printing more money—in hopes of stimulating the economy and paying off debts (Christiano, 2003).
Such action can lead to extreme inflation. Fixed or Rising Costs. Another type of inflation, called cost-push, or seller’s, inflation, occurs when producers increase their prices to offset the cost of labour and materials. In one situation, the demand for a product decreases but the producer cannot lower the price because his labour costs are fixed—usually by union contract—and his suppliers have not lowered their prices. To make up for the reduced volume, he therefore raises his prices. In another situation, demand is stable but wages rise more than productivity (Hart, 2001).
This illustrates the annual inflation rates in the United States from 1966-2004 The actual responsibility for cost-push inflation is a controversial subject. Labour and business each accuse the other. Economists accuse one or both, and the government as well. B. Effects of Inflation Extreme Inflation. Prices rise rapidly, sometimes even daily. As soon as people receive money they spend it for fear that its value will drop even more. Wages do not keep up with the rise in prices and the purchasing power of people dwindles. Savings are wiped out. Some persons, however, gain by runaway inflation.
Speculators are often able to take advantage of rising prices when there are shortages of goods. Debtors gain because they can repay their debts with money that is worth far less than it was at the time of borrowing (Revry, 2004). Creeping Inflation is milder in its effects. It is most noticeable in the cost of living, which increases gradually from year to year. But even mild inflation injures some groups. Over the years, it brings hardship to pensioners and others who must lived on fixed incomes. It reduces the value of savings, and therefore discourages further saving.
Creditors lose because the money they receive in payment of loan is “cheaper” (will buy less) than the money they originally lent. Workers earn more money, but it buys no more than a smaller amount did in the past (Christiano, 2003). On the other hand, business often benefits in certain respects from mild inflation. Corporations are able to pay their debts with ‘cheap” money. Manufacturers are often likely to gain because the price of their products may rise faster than the costs of production, with the result that profits rise even faster than prices (Christiano, 2003). The graph below shows the United States Inflation Forecast Record.