Economic Theory : Types Of Inflation Essay

Economic Theory : Types Of Inflation Essay

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After World War 2, deflation has been commonly defined as a sustained decrease of the price level (“price deflation”). There are two important elements of this definition which is the decrease of the level of prices (inflation rate < 0) and not individual prices. Either in a deflation or inflation, some prices will change more than others as relative prices change every day. The level could remain steady although relative prices change. Secondly the decrease must be sustained which means a continuing process over an extended period of time and without interruption. Inflation can be defined as a sustained, rapid increase in prices. It is accompanied by a correspondingly decreasing purchasing power of the currency. The modern economic theory describes three different types of inflation. The wage-price spiral is linked to cost-push inflation which is due to increasing salaries that cause companies to raise prices to satisfy elevated labor costs which then implicate demand for still higher wages. The demand-pull inflation is a phenomenon which occurs due to increasing consumer demand brought about by easier availability of credit. The third type of inflation is the monetary inflation which results from the expansion in money supply usually caused by quantitative easing. Quantitative easing is an unconventional form of monetary policy where a Central Bank creates new money electronically to buy financial assets, like government bonds. This monetary policy intends to directly increase private sector spending in the economy and return inflation to target. It is commonly said to be “printing money” which governments adopt to cover their deficits.
Inflation is mainly measured by the Consumer Price Index or the Retail Price Index which is...


... middle of paper ...


...it allows for some real adjustments in the labor markets. Nominal wages are very rigid downwards and it will facilitate the real adjustment of companies’s costs which will result in less unemployment. Furthermore, a low but positive inflation rate allows for negative interest rates. If nominal interest rates have reached their zero bound, there is no more margin for traditional monetary policy. Some inflation will result in negative real interest rates which may encourage investment and consumption.
Deflation has a reputation for being something bad since the beginning of the twentieth century thanks to a number of severe deflationary downturns like the great depression in the 30’s in particular. Until then it was quite common for prices to fall gradually and it meant nothing else than goods and services were getting cheaper respectively produced for less resources.

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