2.4.1.1 Definition and types of inflation

Inflation refers to the sustained increase in the general price level of goods and services in an economy over a period of time. It means that, on average, the purchasing power of money decreases, and each unit of currency buys fewer goods and services than it did before. Inflation is typically expressed as an annual percentage rate.

Types of Inflation:

1. Demand-Pull Inflation: Demand-pull inflation occurs when the overall demand for goods and services in an economy exceeds the economy’s productive capacity (output). This can happen when there is strong consumer demand, increased government spending, or robust export demand. As demand outpaces supply, businesses may raise prices to match the increased demand. Demand-pull inflation is often associated with periods of economic expansion and is considered “too much money chasing too few goods.”
2. Cost-Push Inflation: Cost-push inflation results from a decrease in aggregate supply due to rising production costs, such as labor, raw materials, or energy. When production costs increase, businesses may pass on these higher costs to consumers through higher prices, leading to inflation. Factors like supply chain disruptions, wage hikes, or geopolitical events can contribute to cost-push inflation. Cost-push inflation can occur even during economic downturns when demand is relatively weak.
3. Built-In Inflation: Built-in inflation, also known as wage-price inflation, is a self-perpetuating process where rising wages and production costs lead to higher prices, and higher prices, in turn, result in demands for higher wages. It creates a wage-price spiral, where each round of wage increases leads to higher prices, and higher prices lead to further wage demands. Built-in inflation often becomes embedded in an economy’s price-setting mechanism and can be challenging to reverse.
4. Hyperinflation: Hyperinflation is an extremely high and typically accelerating rate of inflation, often reaching astronomical levels, exceeding 50% or even 100% per month. Hyperinflation is usually caused by a collapse in the value of a country’s currency, leading to a loss of confidence in the monetary system. It is often associated with severe economic and political crises, and it erodes the value of money rapidly, causing a breakdown in the normal functioning of the economy.
5. Stagflation: Stagflation is a situation where an economy experiences both stagnant growth (low or negative GDP growth) and high inflation simultaneously. This is considered an unusual and challenging economic scenario because conventional monetary and fiscal policies may not effectively address both issues simultaneously. Stagflation is often linked to supply-side shocks, such as rising oil prices or adverse productivity shocks.