Inflation is a consistent and appreciable rise in the general price level. In other words, inflation is the rate at which the general level of prices for goods and services is rising and consequently the purchasing power of currency is falling
The main causes of inflation in India are as follows:
Increase in Money Supply:
Inflation is caused by an increase in the supply of money which leads to an increase in aggregate demand.
The higher the growth rate of the nominal money supply, the higher is the rate of inflation.
Increase in Disposable Income:
When the disposable income of the people increases, it raises their demand for goods and services.
Disposable income may increase with the rise in national income or reduction in taxes or reduction in the saving of the people.
Increase in Public Expenditure:
Government activities have been expanding due to developmental activities and social welfare programmes.
This is also a cause for price rise.
Increase in Consumer Spending:
The demand for goods and services increases when they are given credit to buy goods on a hire-purchase and instalment basis.
Cheap Money Policy:
A cheap money policy or the policy of credit expansion also leads to an increase in the money supply which raises the demand for goods and services in the economy.
In order to meet its mounting expenses, the government resorts to deficit financing by borrowing from the public and even by printing more notes.
This raises aggregate demand in relation to aggregate supply, thereby leading to an inflationary rise in prices.
Black Assests, Activities and Money:
The existence of black money and black assets due to corruption, tax evasion etc., increase the aggregate demand. People spend a lot of money, lavishly.
Black marketing and hoarding reduce the supply of goods. These trends tend to raise the price level further.
Repayment of Public Debt:
Whenever the government repays its past internal debt to the public, it leads to an increase in the money supply with the public.
This tends to raise the aggregate demand for goods and services.
Increase in Exports:
When exports are encouraged, the domestic supply of goods decline. So prices rise.
Effects of Inflation
The effects of inflation can be classified into two heads:
Effects on Production and
Effects on Distribution.
Effects on Production:
When inflation is very moderate, it acts as an incentive to traders and producers.
This is particularly prior to full employment when resources are not fully utilized.
The profit due to rising prices encourages and induces business classes to increase their investments in production, leading to the generation of employment and income.
However, hyper-inflation results in a serious depreciation of the value of money and it discourages savings on the part of the public.
When the value of money undergoes considerable depreciation, this may even drain out the foreign capital already invested in the country.
With reduced capital accumulation, the investment will suffer a serious setback which may have an adverse effect on the volume of production in the country.
This may discourage entrepreneurs and businessmen from taking business risk.
Inflation also leads to hoarding of essential goods both by the traders as well as the consumers and thus leading to a still higher inflation rate.
Inflation encourages investment in speculative activities rather than productive purposes.
Effects on Distribution
Debtors and Creditors:
During inflation, debtors are the gainers while the creditors are losers.
The reason is that the debtors had borrowed when the purchasing power of money was high and now repay the loans when the purchasing power of money is low due to rising prices.
The fixed-income groups are the worst hit during inflation because their incomes being fixed do not bear any relationship with the rising cost of living.
Examples are wage, salary, pension, interest, rent etc.
Inflation is a boon to the entrepreneurs whether they are manufacturers, traders, merchants or businessmen because it serves as a tonic for business enterprise.
They experience windfall gains as the prices of their inventories (stocks) suddenly go up.
The investors, who generally invest in fixed interest yielding bonds and securities have much to lose during inflation.
On the contrary, those who invest in shares stand to gain by rich dividends and appreciation in the value of shares.