Inflation

Inflation as essentially a situation in which the general price level was rising very rapidly and so the value of money declining precipitously.

 

Type of inflation

1)Demand pull inflation

2)Cost-push inflation

3)Built in inflation

4) Creeping inflation

5) Moderate inflation

6) Suppressed inflation

7) Hyper inflation

     

     Cause of inflation

 

Inflation means a continue fall in real money balances and so money market equilibrium requires a continuously rising nominal rate, with a steady rate of inflation,  this means a continuously rising real interest rate which can be expected to reduce aggregate demand. It seems then, that in the absence of monetary expansion, a steady inflation is incompatible with persistent excess demand for commodities.

There are number of other way in which price rise might reduce aggregate demand.

1) The real value of nominal financial assets is reduced and this may reduce consumption expenditure.

2) Real tax revenue may rise with a non-indexed tax system and this may result in a decline is disposable income and hence consumption.

3) In an open economy net exports may fall because of declining.

Competitiveness unless the exchange rate is adjusted so as to offset this effect completely.

4) Income distributed effects may occur. If  wages lay behind price then profit receipt gain and wage earns suffer.

 

 

Inflation and uncertainty

 

 

It is sometimes asserted that inflation is undesirable because it produces greater uncertainty and this is held to be bad. To support the link between inflation and uncertainty evidence that the level and variability of inflation are positively related is sometime cited.

However, if inflation is more variable it is not necessarily more uncertain. It is more uncertain it is necessary to find someway of explaining how inflationary expectation change with inflation. This has been examined in two ways.

-> First looks at the variance of forecast of inflation reported. It seems that such variance is significantly related to the rate of inflation individual forecast of inflation  become more dispersed, the higher the rate of inflation.

-> The second approach is to use a forecasting equation for the inflation rate and examine the time series the variance of error term.

 

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