INFLATION

The term inflation has been used in many senses. It is very difficult to give a generally accepted, precise and scientific definition of this term. When representative paper money with full bullion backing used to be in circulation, inflation was considered as a situation in which the quantity of money in circulation exceeded the amount of reserves backing it. Gradually, this notion of inflation was given up and inflation came to be known as a state in which the quantity on money in circulation expanded faster than the growth of output causing a continuous price rise. This is what Coulbourn means when he defines inflation as, “too much money chasing too few goods”. Kemmerer also thinks that inflation will exist when the amount of money in the country is excess of the physical volume of goods and services. Classical economists were of the view that inflation is fundamentally a monetary phenomenon. According to them, inflation is mainly due to increase in the quantity of money, given the level of full employment. Here price rises in proportion to the increase in money supply. Inflation proceeds at the rate at which the money supply expands. In the words of Friedman, ”Inflation is always and everywhere a monetary phenomenon… and can be produced only by a more rapid increase in the quantity of money than output”. Thus, according to the quantity approach, the volume of money is responsible for the rise in prices through fall in the value of money. This definition on the basis of the quantity theory of money continued to be in use till the Great Depression of 1930s revealed the limitations of the quantity theory of money. The definition was modified accordingly in the wake of Keynesian revolution. Pigou, a contemporary of Keynes, defined inflation in terms of changes in money income. In his view, inflation exists when money income is expanding more than in proportion to income earning activity.

Keynes linked up the concept of inflation with the phenomenon of full employment. Like Pigou, Keynes relates inflation to a rise in price level that comes into existence after the stage of full employment .According to him, inflation refers to a rise in price level after full employment level has been achieved. In such a situation of price rise, output will not increase in the economy.

Keynes distinguished this inflation from rise in prices accompanied by an increase in output. If an economy is working below full employment level, there exists large number of unemployed men and unutilized resources. In this case, an increase in demand as a result of expansion of money will raise not only the price level, but also the volume of output and employment in the system. This rise in the price level is referred to as inflation or semi-inflation or partial inflation.

Under inflation, prices rise slowly and steadily as the pressure of prices rise is offset by the increase in output. In general, an increase in the money supply will be more likely to raise output rather than prices, the more unemployment there is.