This is the second serious problem that worries modern public authorities. Ordinarily inflation is associated with rising price conditions. But to be accurate we can define inflation as a situation under which general level of prices shows tendency of cumulative and continuous upward rise.
For rising prices to be considered inflationary, all these three conditions must be satisfied. In the first place, the rising trends of the prices should be general and not sectional. Consumers and producers, goods, raw materials, interest rate, wages, imports and exports prices should all contain an element of inflationary pressure. In the second place, such price changes must be cumulative in the sense that the prices of finished products should have risen because of higher prices of raw materials, or the prices of goods should have risen because of higher wages and vice versa. Finally, inflationary price rise should be continuous. The rounds of rising prices should be repeated month after month and year after year.
Inflationary situations in almost all parts of the world have become very common in the post World War II period. A high degree and long phases of inflation are very a complex phenomena. There are a variety of contributory causes. These are the forces active both on the supply (cost of production) and demand (total private and public expenditure) sides of the economy. A section of economists, such as Sir Irving Fisher, A.C. Pigou, Dr. Friedman, known as quantity theorists or monetarists uphold the view that an excessive supply of money, or unexpected changes in the money supply, is the chief cause of inflation.
On the contrary, Keynes and his followers held the view that so long as there exist unutilized resources and unemployed labor, an increased money supply will not cause inflation. In a modern economy year after year there is some increase in the supply of the quantity of money in circulation. Normally, the annual increase in the money supply is 3 to 4 percent. This is essential to keep pace with increase in the productivity, increase in the size of the population and changes in some other dynamic forces. Therefore annual rise in the price level to that extent (of the order of 4 percent) is not considered inflationary. Any further rise in the price level in excess of 4 percent will then cause an inflationary pressure on the prices.
Suitable measures, such as controlling money supply and public expenditure, regulating prices, improving supply conditions, restricting wage and cost hikes, can be introduced to contain inflation and to restrict price level. Various theories analyzing inflationary price changes have been developed. These are: Cost Push or Demand Pull. Besides internal causes, even international trade activities cause spread of inflation through the imports of goods and services.
1 Macro Aggregates