Inflation is a general increase in prices and fall in the purchasing value of money. “Too much money in circulation causes the money to lose value”-this is the true meaning of inflation.
What is Inflation.
The rate at which the general level of prices for goods and services is rising, and, subsequently, purchasing power is falling. Central banks attempt to stop severe inflation, along with severe deflation, in an attempt to keep the excessive growth of prices to a minimum. (Investopedia) a. Kinds of Inflation
Inflation means a sustained increase in the general price level. However, this increase in the cost of living can be caused by different factors. There are many types of inflation but the main two types of inflation are; 1. Demand pull inflation: This occurs when the economy grows quickly and starts to ‘overheat’ Aggregate demand (AD) will be increasing faster than aggregate supply (LRAS). 2. Cost push inflation: This occurs when there is a rise in the price of raw materials, higher taxes, etc.
1..Demand Pull Inflation
This occurs when AD increases at a faster rate than AS. Demand pull inflation will typically occur when the economy is growing faster than the long run trend rate of growth. If demand exceeds supply, firms will respond by pushing up prices. Simple diagram showing demand-pull inflation
The UK experienced demand pull inflation during the Lawson boom of the late 1980s. Fuelled by rising house prices, high consumer confidence and tax cuts, the economy was growing by 5% a year, but this caused supply bottlenecks and firms responded by increasing prices.
This graph shows inflation and economic growth in the UK during the 1980s. High growth in 1987, 1988 of 4-5% caused an increase in the inflation rate. It was only when the economy went into recession in 1990 and 1991 that we saw a fall in the inflation rate. 2..Cost Push Inflation
This occurs when there is an increase in the cost of production for firms causing aggregate supply to shift to the left. Cost push inflation could be caused by rising energy and commodity prices. Simple Diagram showing cost push inflation.
3. Wage Push Inflation
Rising wages tend to cause inflation. In effect this is a combination of demand pull and cost push inflation. Rising wages increase cost for firms and so these are passed onto consumers in the form of higher prices. Also rising wages give consumers greater disposable income and therefore cause increased consumption and AD. In the 1970s, trades unions were powerful in the UK. This helped cause rising nominal wages; this was a significant factor in causing inflation. 4. Imported Inflation.
Depreciation in the exchange rate will make imports more expensive. Therefore, the prices will increase solely due to this exchange rate effect. A depreciation will also make exports more competitive so will increase demand. 5. Temporary Factors.
The inflation rate can also increase due to temporary factors such as increasing indirect taxes. If you increase VAT rate from 17.5% to 20%, all goods which are VAT applicable will be 2.5% more expensive. However, this price rise will only last a year. It is not a permanent effect.
6. Core Inflation
One measure of inflation is known as ‘core inflation’.This is the inflation rate that excludes temporary ‘volatile’ factors, such as energy and food prices. The graph below shows inflation in the EU. The headline inflation rate (HICP) is more volatile rising to 4% in 2008, and then falling to -0.5% in 2009. However, the core inflation (HCIP – energy, food, alcoholand tobacco) is more constant.
b. People who are being affected by inflation
Macro Economic Effect in Bangladesh:
The inflationary situationin Bangladesh is on the rising trend, especially since August 2009, primarily owing to the soaring increase in food prices. The food price hike has accelerated the general inflation rate in the country. If the food price level rises at an existing...
References: Akhtaruzzaman, Md. “Inflation in the Open Economy: An Application of the Error Correction Approach to the Recent Experience in Bangladesh,” Working Paper Series, WP 0602 (2005), Policy Analysis Unit (PAU), Research Department, Bangladesh Bank.
Bruno, M. and W. Easterly. “Inflation Crises and Long-Run Growth,” World Bank Policy Research Working Paper No. 1517 (1995).
Khan, M. S. and A. S. Senhadji. “Threshold Effects in the Relationship between Inflation and Growth,” IMF Staff Papers, Vol. 48, No. 1 (2001).
Tobin, J. “Money and Economic Growth,” Econometrica, 33 (1965), pp. 671-684.
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