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Development Economics

Inflation: Causes, Consequences and Remedies


Prof. Gardener Ackley has Defined Inflation in the Following Words:

“When the price level rises continually with a great speed, this situation is called inflation.”

According to Prof A.P. Lerner:

“Inflation is a situation when demand for goods and services has become greater their supply.”

According to Prof. Hanson:

“When prices tend to rise more rapidly than the production of goods and services, called inflation.”

In the period of inflation, the income of the people seems to be high. It means .. have enough money apparently but their purchasing power decreases.

The inflation rate as measured by Consumer Price Index (CPI) represents the trend of prices of goods and services in the economy. The CPI is broadly divided into two major groups: (i) Food group (ii) Non-food group.

Consequences or Effects of Inflation:

Investment and Production:

In the period of inflation, the profits of entrepreneurs and traders increase rapidly and they expand their investments to a great extent to avail themselves of this opportunity. It increases the quantity of production and opportunities of employment.

But, if economy has already obtained the level of full employment, then there is no possibility of increase in real output. So, prices of goods and rewards of factors increase. If inflation is not controlled in the neck of time, it takes form of hyperinflation under self-generating effect.

Economic Growth:

It is imperative in developing countries to accelerate the speed of economic growth so that these countries may pass through the stages of economic development rapidly. In these countries, inflation helps in utilizing their resources. It causes an increase in national income and opportunities of employment. Furthermore, when big projects of public works are completed agricultural, industrial and commercial sectors make progress. Owing to increase in the quantity of output, the intensity of inflation lessens to some extent.

Living Standard:

When the prices of goods rise, wages of labourers do not increase with the same rate. Their purchasing power falls down and they can buy less quantity of goods and Services with their salaries and wages. Their costs of living increase and their living standard falls.

Discouragement of Savings:

As the purchasing power of the people decreases in case of inflation and they can hardly make their both ends meet with their incomes, so they cannot think of savings even. Thus, there is negative effect on savings in case of inflation.

Reduction in Exports:

In case of inflation, prices of goods increase in the country. Demand for its products in foreign countries falls and exports of the country reduce. Consequently, its balance of trade becomes unfavourable. The country has to devalue its currency. If a country, faces inflation for several years, then continuous deficit in its balance of trade causes so much increase in foreign loans that its payment becomes very difficult.

Increase in the Cost of Govt. Projects:

Development projects are being carried on in the developing countries to make rapid development. Big projects with heavy costs e.g., dams, power-houses and means of transportation and communications are under completion. The costs of these projects increase than their estimates during inflation and the government has to borrow from internal and external resources to complete these projects. It has to increase the rate of taxes. Hence, inflation causes an increase in government expenditures and it creates big difficulties for the government.

Inequality in Distribution of Income:

In capitalistic economy distribution of wealth is already unequal. The society is divided into two classes, the rich and the poor. If inflation emerges in the country, the profits of big entrepreneurs, merchants, industrialists and landlords increase to a great extent. In this way, the rich get richer and richer. On the other hand, the real incomes of the labour and government servants fall and they get poorer and poorer. Thus, inflation makes distribution of wealth more unequal.

Causes of Inflation:

The following are the causes of inflation.

Increase in the Quantity of Money:

If the quantity of money in the country increases due to the issuance of notes in more quantity by the central bank, the prices of goods rise owing to the rise in the supply of money and the country becomes the prey to inflation.

Increase in the Demand for Goods:

If the demand for goods becomes higher than the supply of goods, then prices of goods rise and inflation is created in the country.

Increase in Costs of Production:

If wages of labour in a country increase or raw material becomes dear or the government levies taxes on goods, the costs of production of goods increase. The traders and merchants increase the prices of goods and it becomes the root cause of inflation.

Development Expenditure:

The governments of the developing countries have launched development projects, and they have to make heavy expenditures on these projects. As a result, the demand for goods increases but their supply does not increase at the same rate. Thus, these countries have to face the problem of inflation.

Inflation on International Level:

In the present age, all the countries of the world are interconnected with each other because of international trade. That is why all the countries are influenced by the increase in prices in one country. For example, many countries are facing the problem of inflation because of the increase in oil prices by Arabian countries.

Rapid Increase in Population:

If the population of a country increases rapidly, the demand for goods and services increases continuously but the production of consumer goods does not increase with the same rate. So, the shortage of goods causes an increase in the prices of consumer products and the prices of capital goods also increase simultaneously. As a result, raising prices encircles whole of the country.

Increase in Investment:

If the investment increases than savings, inflation emerges in the country because if the increase in savings is not equal to the increase in investment, then demand for goods rises and the rise in the demand for goods results in rise in prices.

Export Policy:

If the government of a country starts exporting goods to a foreign country at a large scale, it results in shortage of goods in the country and their prices rise.

Unfavourable Conditions:

If the conditions are unfavourable for production, production of goods falls down and their prices rise. For example, if agriculture production falls down owing to draught or excessive rains, floods, natural calamities and crop-diseases, the agricultural output will decrease. As a result, prices of agricultural goods will rise.


If the employers and the employees are not on good terms in a country, the labour goes on strike to pressurize their employers so that their demands may be accepts. National production decreases due to these strikes and goods become scarce and the prices tend to rise up.

Political Conditions:

If there is political instability in the country, riots, anarchy and disorder become the order of the day, then production units leave the industry or cut down production. In this way, production decreases and prices of goods rise.

Smuggling and Hoarding:

If people living in the country are lusty for profit, the anti-social elements try to increase their incomes by illegal and unfair means. They smuggle goods to foreign countries to earn excessive profit. They also create an artificial shortage of goods by hoarding and black-marketing. This situation leads the country to the problem of inflation.

Methods to Control Inflation/Remedies to Inflation:

The following remedies are suggested to overcome inflation.

Monetary Measures:

The measures taken by the central bank of a country to overcome inflation, are called monetary measures. These measures are as follows.

Increase in Bank Rate:

The rate at which central bank advances loans to commercial banks is called bank rate. Central bank increases bank rate to overcome inflation so that commercial bank increases the rate of interest. The traders and the entrepreneurs decrease taking loans from the commercial banks and the total quantity of money in the country contracts. On the other hand, people start saving a major part of their incomes so that they may get interest by lending their savings. As a result, demand for goods decreases and tendency of rise prices breaks down.

Open Market Operation:

The central bank sells government securities and bonds in money market overcome the problem of inflation. The people withdraw their money from commercial banks and buy them. Their money is deposited in central bank and commercial bank cannot issue more loans to the people. The velocity of circulation of money become slow and demand for goods falls. Consequently, prices cease rising up.

Increase in Reserve Requirement:

To control inflation, central bank raises reserve ratio. It decreases the power of issuing loans of commercial banks and supply of money decreases to some extent.

Revaluation of Currency:

To control inflation, national currency is revalued in comparison with foreign currency so that exports may be decreased and the supply of goods may be increased in the country.

Fiscal Measures:

The measures that a government takes to control inflation by changing its income and expenditures are called fiscal measures.

Reduction in govt, Expenditure:

The government of a country decreases its expenditure to control inflation. It wipes out the less important expenditures. As a result, demand for goods decreases.

Increase in Taxes:

To overcome the problem of inflation, the govt. of a country increases the rate of present taxes and it levies some new taxes as well. Because of these taxes, purchasing power of people decreases and they reduce the demand for goods and the increase in prices of goods ceases.

Encouragement of Savings:

The government of a country encourages savings by different ways so that people may save money and cut down their consumption expenditures. In this way, demand for goods falls and it helps to control inflation.

Miscellaneous Measures:

Increase in the Production of Goods and Services:

The best way to control inflation is that production of goods and services in the country should be increased. In this way, supply of goods and services will increase and pressure of inflation will be decreased.

Decrease in Exports and Increase in Imports:

The export of goods of daily use should be decreased and import of scarce goods hold be increased. In this way, the increasing level of prices can be kept under control.

Control on Prices:

The govt. of a country can overcome the problem of inflation by controlling the prices of basic necessities.

Control on Population:

The government should make hectic efforts to solve the problem of over population. So that consumption of goods may be decreased. To achieve this end, people be aware of the importance of family planning. Moreover, literacy rate should be Increased.

Elimination of Smuggling, Hoarding and Black-marketing:

The government should take serious steps to eliminate smuggling, hoarding and black marketing so that people may abstain from these social evils. If it happens, artificial scarcity of goods will be out of question and prices of goods will not increase.


The availability of food items and any adverse external hike in prices. However, the revision of any energy tariffs and imposition of taxes may pose risk to inflation.

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