Concept and Definition of Inflation

In general, inflation means the increase in general price level or decrease in purchasing power of money (or value of money). Inflation usually refers to a general rise in the level of prices of goods and services over a period of time. This is also referred to as price inflation. The term inflation originally referred to the debasement of currency, and was used to describe increases in the money supply; however, debates regarding cause and effect have led to its primary use today in describing price inflation. Inflation can also be described as a decline in the real value of money. When the general level of prices rises, each monetary unit buys fewer goods and services. Inflation is measured by calculating the inflation rate, which is the percentage rate of change for a price index, such as the consumer price index.

Economists generally agree that high rates of inflation and hyperinflation are caused by high growth rates of the money supply. Views on the factors that determine moderate (neither large nor small) rate of inflation are more varied. However, there is general consensus that in long run, inflation is caused by money supply increasing faster than the growth rate of the economy.

Inflation originally referred to the debasement of the currency, where gold coins were collected by the government, melted down, mixed with other metals and reissued at the same nominal value. By mixing gold with other metals, could increase the total number of coins issued using the same amount of gold. However, this action of government increased the money supply, and lower the relative value of money. As the real value of each coin had decreased, the consumer had to pay more coins in exchange for goods and services of the some value. In the 19th century, the word inflation started to appear as a direct reference to the action of increasing the amount of currency units by the central bank.

In some schools of economics and particularly in the United States in the 19th century, inflation originally was used to refer to increase of the money supply, while deflation meant decreasing it. However classical political economists from Hume to Ricardo did distinguish between and debate the cause and effect: Balloonists, for example, argued that the Bank of England had over-issued banknotes and caused the depreciation of bank notes (Price inflation).

There are many definitions of inflation. By inflation most people understand a sustained and substantial rise in prices. For example, Crowther defines inflation as a state in which the value of money is falling, i.e., prices are “rising”. According to Harry G. Johnson, “we define inflation as substantial increase in prices”. Milton Friedman writes: “By inflation I shall mean a steady and sustained rise in prices.”

According to these definitions, inflation is a process of change in the economy which has the following features:

(1) There is an abnormal-more than 8% rise in the price level;

(2) The price level rises continuously for over 2-3 years;

(3) Too much money chases too few goods. That is, there is an excessive supply of money in relation to the supply of goods and services demanded by the people.

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