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Causes Of Inflation

December 2nd, 2009

Causes Of Inflation Inflation is a monetary phenomenon .It is also affected by the fluctuations of wages, prices and interest rates. There are two schools of thought which define the causes of inflation. In monetarist school of thought, the availability of money in the market causes rise in prices of goods and services and prices and wages adjust quickly to make other factors merely marginal. In the Keynesian view, prices of goods and wages adjust at their own rates, which fluctuate real output.

There are three major types of inflation:

  • Demand-pull inflation: Here inflation is supposed to be caused by increases in aggregate demand due to availability of excess money which can be because of increased private and government spending, etc.
  • Cost-push inflation: It is caused by drops in aggregate supply due to increased prices of inputs. For eg: a sudden decrease in the supply of oil, which would increase oil prices. Manufacturers for whom oil is a part of their costs will then pass this on to consumers in the form of increased prices.
  • Built-in inflation: It is induced by expectations, inked to the “price/wage spiral” because it consists of workers trying to keep their wages up with prices and then employers passing higher costs on to consumers as higher prices .This forms a “vicious cycle.”

According to Monetarists inflation is caused by an increase in the amount of money in market relative to the capability of the economy to supply. This happens when governments finance spending in a crisis, such as a civil war, by printing money excessively, often leading to hyperinflation, a condition where prices can double in a month or less. The current rise in inflation all over the world is said to be because of this theory. To subvert the possibility of a sub prime crisis the Federal Reserve (Central Bank Of the U.S.) is printing excessive money and introducing large supply of cash in the market. This excessive supply is being used by people to buy more goods. This results in rise in demand of the goods thereby increasing their prices.

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