To know the reasons behind the inflation, first of all, think about an example, if I gave you a note of a hundred rupees in the year 1958 and you kept it hidden in your secret place for 60 years and then you took out that note today and used it in the market, then the value of that note would have reduced to the small value of 1 rupee 20 paise in comparison to 1958.
Let me explain it to you from another better angle, if you did not understand, if you buy something worth 100 rupees today, it would have cost 1 Rupee 20 paise back in 1958. That is 100 rupees of today is equal to 1 rupee 20 paise of 1958. This is because of inflation.
Inflation means the dearness of things that makes things costlier for all of us every year and year. Why does inflation occur and what are the reasons behind the inflation? Is it good or bad? And what is the relation between inflation, unemployment, mad other economic factors? I will try my best to teach all about inflation through the article where I will explain this "ghastly" inflation to you.
Why does inflation happen?
First of all, a very important question. Why does inflation happen, and who is causing it? Are some government officials increasing the prices of things arbitrarily? But It is not so. There are several reasons for inflation but I did like to discuss four main reasons for inflation in this article.
1. Economic Boom
The first reason behind the inflation is very simple an 'economic boom' which means good economic growth. When the economic growth is good, then there's more money in the hands of the peoples who can spend it on different items.
When there's more money in the hands of the people, they can spend it on different items. That is, the demand for everything would go up in the economy when demand goes up, the businesses and companies that manufacture their products seek to incerse the prices in a bid to earn more and more profit since so Jonah people are willing to buy, so they increase the price of the goods which will then lead to inflation.
Explaining this with an example, imagine an airplane with 100 seats and 100 passengers have to board that plane. But there are only 10 first-class seats and 90 economy class seats. Now if the passengers are given enough money to be able to afford a first-class seat, they'll all want to book a first-class seat. But the number of seats is only 10, not all of them can have a first-class seat, so what would happen as a response? In response to it, the airplane would incerse the prices of its first-class seats so that only those people who have more money can afford to book a first-class seat, so basically there is inflation.
This type of inflation is called "demand-pull inflation". Demand-pull inflation is when inflation rises with the rise in demand.
2. Increase In Prices Of Raw Material
The second reason behind the inflation is an increase in the prices of raw materials due to different reasons. For example, if the prices of wheat and rice rise due to a bad monsoon or season or some other natural disaster, the price of oil rise, or a new tax imposed by the government lead to a rise in the price of one of the raw materials than the companies that manufacture products using these raw materials.
They'd have to hike the prices of the products to make profits since manufacturing them would become costlier which would ultimately lead to inflation. This inflation is called " cost-push inflation".
3. Increase In Employee Salaries
The third reason behind the inflation is an increase in salaries. No, I'm not joking. When the companies or government raise the salaries of the employees, then they have to increase the price of their products as well to be able to still make profits.
This inflation is called "wage push inflation". There could be other reasons for this as well if the unemployment levels are at very low levels in some countries, then it is extremely difficult for the companies for replacing their employees, and if they are not able to replace them, there needs to incerse their salaries and this also again triggers inflation.
4. Currency Depression
Finally, the fourth reason behind the inflation is currency depreciation. This can happen due to several different reasons, out of which one of the most important reasons is the printing of more notes by the government which leads to the currency starts losing its value and this is a very dangerous reason.
This could also potentially trigger hyperinflation which is happened in Venezuela from 2016 to 2019 years and happened in Zimbabwe in 2008. If the inflation rate touches even 10% in our country, then it would cause the people to comment that things are becoming extremely dear very fast. But in Venezuela, between 2016 and 2019, the inflation rate was more than 5 crore percent!
Taking the example of Zimbabwe, around 2008, the currency of Zimbabwe was losing its value at such a rapid pace that the government began printing 1 million dollars and 1 billion dollars notes! And there existed even a 1 trillion dollar note in Zimbabwe dollars and do you know what the value of that 1 trillion Zimbabwean dollar note was? Just 1 US dollar! This is the extent to which money can lose its value in the case of hyperinflation. But this is not only about hyperinflation, it is a very looks topic on its own.
In Lock Down
When the lockdown applied in the major countries due to COVID 19, the inflation rate in most of the countries in that interval going down. Think about why this was happening.
It is because of the decrease in demand in the wake of the lockdown that had been occurring throughout the world. People are not buying many things and do not much travel. The people do not have money to spend because their businesses have shut down and so, there had been a decline in overall demand and the opposite of the " demand-pull"(which I told you about as the first reason for inflation) is happening.
Since the demand for the products was going down, therefore the inflation as a response to this, many countries had decided to transfer money to the people distribute it for free.
I'd like to pose another interesting question before you. Is inflation necessary? What if there was 0%, inflation? Observing superficially, you may think that, this would be very good, as things would stop becoming costlier and that it is good for you, as you will be able to afford it for cheap, not essential to pay more. You would be able to save up more and over time the value of money would not depreciate either. So this would be another great thing!
But, analyzing deeply the reasons that lead to inflation then you would understand that 0% inflation is not a good thing. Reasons behind why 0% inflation is not good:
• This would mean that companies would not raise your salaries.
• Your salary would remain constant and since salaries never go down. Therefore, in general, inflation always stays positive.
• There is a third reason as well if there is deflation, that is, the prices of things keep decreasing every year, then the people would not want to spend money. They would want to save up, first of all, the value of money is increasing, if deflation continues to happens, then five years on, the item that one wishes to buy would come for cheaper.
So they would want to buy it five years later instead of buying it now. This would cut down the overall public expenditure. Lesser expenditure would mean that the business would start incurring losses would translate to people losing their jobs which would then cause unemployment to rise.
I've told you about a very long and convoluted connection. You might wonder if it happens, so yes friends it does. It is a very interesting relation between unemployment and inflation. The graph is called the "Phillps Curve". The graph shows us the inverse relationship between unemployment and inflation or says they are inversely proportional to each other.
If there's economic growth, there will be an increase in inflation and unemployment would go down and this is a very interesting explanation because you would not expect this to happen, but it happens in reality.
But as obvious, there are some limitations where the Phillips Curve is not valid. For example, in the case is hyperinflation, it isn't that Venezuela has 100% employment and 0% unemployment. Some other factors come into play there. There are also political factors that cause inflation to tip. But generally, the graph is valid.
What is the best level of inflation?
A question arises, excessive inflation is bad because it would cause hyperinflation and increase dearness nominal inflation is also bad. After all, it would cause unemployment to rise. So, what is the optimum or good level of inflation that a country should have to maintain?
This is 2% for the developed countries. The central banks and the government of the developed nations have decided that they should maintain an inflation rate of about 2%. If it is more, then they would try and reduce it, and if it is less, they would try and increase it.
For India, this rate is 4% with a margin of ±2%. So the ideal inflation rate in India should be around 6%. This maintains the prices stable and maintains the levels of unemployment at their lowest. This ensures maximum employment. So, if the government wants to control inflation, how can it do that?
• There can be several ways to do this. Generally, the central bank of a country is responsible for controlling the inflation rate, and normally, the central bank RBI, in the case of India controls the inflation rates by increasing/decreasing its interest rates, if RBI increases its interest rates (which are called repo rates) which are charged on loans given to other banks.
Then fewer banks would want to take loans and these banks, in turn, would increase their interest rates as well which would reduce the number of people wanting to take loans. This would result in a lesser amount of money being circulated in the economy and if this happens, then inflation would go down.
And if RBI slashes its interest rates, then indirectly, though other banks of India, more people would want to take loans from banks and this would help to make the inflation up. So the inflation rate can mainly be controlled by increasing or decreasing the interest rates.
• But there are other ways as well inflation can also be controlled by printing more notes. Printing more notes would cause inflation to rise.
• The government can also control the inflation rate by imposing more taxes.
• The government can also control inflation by spending more or by spending less.
All these are the major methods by which the government can control the inflation of the country.