Inflation is one of the most commonly used terms in economics because it affects individuals, businesses, and governments alike.
Despite this, the concept is still not adequately understood.
Hence, we will look at the concept of " inflation" in this post.
Inflation can be defined as a general and continuous increase in the prices of goods and services in an economy.
It is a rise in the average price of goods and services in the economy.
Inflation implies that on average, the prices of goods and services in the economy are increasing.
Two things to note about inflation.
First, a rise in the price of a single commodity in the economy does not constitute inflation but a rise in the average prices of goods and services constitutes inflation.
Secondly , the rises in the average prices of goods must be continuous for it to be called inflation. If the rise in the average price of goods and services is a one-off, then it is not inflation.
Classification of inflation
1. Creeping inflation: This occurs when the prices of goods and services increase at a slow rate.
It is used to describe a slow and gradual increase in the general price level of goods and services.
A sustained annual rise in average prices of less than 3 percent per annum falls under the category of creeping inflation.
Most central banks regard creeping inflation as safe and essential for economic growth.
This is because creeping inflation encourages investment and growth as businesses seek to take advantage of the rising prices.
2. Walking inflation: This occurs when the prices of goods and services increase at a moderate rate.
A sustained annual rise in average prices between 3% to 10% per annum falls under the category of creeping inflation.
Walking inflation serves as a warning signal for the government to control it before it turns into running inflation.
If the government does not control walking inflation, it turns to run inflation
3 . Running inflation: This occurs when the prices of goods and services increase at a more than moderate rate.
A sustained annual rise in average prices between 10% to 25% per annum falls under the category of running inflation.
Running inflation has a significant adverse effect on the economy.
First, it causes the currency of a currency to lose value in the global economy.
Secondly, it makes fixed-income earners poorer as the purchasing power of their income will be reduced significantly.
Lastly, galloping inflation usually marks the start of potential economic instability.
For this reason, most governments try to eliminate galloping inflation by implementing strong monetary and fiscal policies.
4. Hyperinflation: If the government and other policymakers are not able to control gallop inflation, it results in a devastating form of inflation, called hyperinflation.
Hyperinflation is the extreme form of inflation where the prices of goods and services increase at a fast rate.
A sustained annual rise in average prices above 25% per annum falls under the category of hyperinflation.
During hyperinflation, prices tend to rise very fast at double or triple-digit rates such that the purchasing value of money reduces frequently.
In extreme cases of hyperinflation, the value of the currency can become completely worthless, leading to a breakdown in the economy and social unrest.
Hyperinflation could get so extreme that the inflation rate is no longer measurable or the inflation is no longer controllable.
Indeed, during the period of hyperinflation, the prices rise many times every day.
Causes of Inflation
There is not one cause of inflation. Economists have given different causes of inflation, including the demand-pull theory, cost-push inflation, and monetary theory.
1. Demand-pull theory: This theory believes that inflation is caused by an increase in the aggregate demand for goods and services in an economy.
According to this theory, when an increase in aggregate demand outweighs the increase in aggregate supply, the price level will increase and inflation will creep in.
In other words, when consumers demand more goods and services that are available in the economy, prices will rise as sellers increase their prices to take advantage of the situation.
Demand-pull inflation could result from an increase in consumer confidence or government spending,
2. Cost-push theory: According to this theory, inflation is caused by an increase in production costs, which causes producers to increase the prices of their goods and services.
Cost-push theory believes that inflation is caused by factors that cause aggregate supply to reduce.
Such factors include a rise in the cost of production, a decrease in the quantity produced, an increase in government taxation, an increase in the price of raw materials, labor, or energy,
3. Monetary theory: According to the monetary theory, inflation is caused by a growth in the money supply.
In other words, the theory states that inflation is caused by an excessive supply of money, which causes its value to drop and the average prices of goods and services to increase.
That is, when the money supply grows faster than the rate of economic growth, prices will increase as the value of money decreases.
It is important to note that while these theories provide different explanations for inflation, they are not mutually exclusive.
Inflation can be caused by a combination of demand-pull factors, cost-push factors, and monetary factors.