Definition: Inflation refers to the sustained or considerable rise in the general price level of goods and services over a period of time. Inflation is characterized by low purchasing power as with an increase in the prices, few goods and services can be bought from each unit of the currency.
There is no universally accepted definition of inflation; it kept changing with the change in the perceptions of the economists. Some believed that inflation exists when the proportion of money income increases more than the increase in the earning activity. While others believe it is characterized by increased income chasing few goods due to the appreciable rise in their general price level.
An economy with a moderate rate of inflation is desirable. The desirable rate is determined on the basis of price rise that contributes in the following ways:
- Helps in production and employment and keep the economic outlook optimistic.
- Promotes the mobilization of resources, both savings, and investments, what is called as the inflationary financing.
This desirable rate of inflation varies from country to country and from time to time. Now the question arises that what is the desirable rate? There is no specific answer to this question, but, however, on the basis of past experiences, it is often suggested that 1-2% of inflation in developed countries and 4-6% in the developing countries is considered to be a desirable limit of moderate inflation.
In certain conditions, the price rise exceeding the prescribed limits of moderate inflation (both developed and developing economies) is not considered to be inflationary. These are:
- When the price rises due to the change in the composition of GDP (Gross Domestic Product). Such as, during the period of economic growth the proportion of low priced goods (agricultural goods) decreases while the proportion of high-priced goods (cars, TV sets, computers, etc.) increases. As a result, the price index number rises. This rise in price is not considered to be inflationary.
- Any rise in price due to the qualitative change in the product is not inflation. For example, the qualitative improvement in the car, in the form of power steering, power brake, airbags, automatic gear change, etc., involves an increase in the cost of production due to which the price rises. Such rise in the price is not inflation.
- A short-run rise in the price due to a sudden rise/fall in demand or a sudden rise/fall in the supply of goods and services is not inflation. Sometimes, the price rises due to a sudden surge in demand and/or sudden decrease in the supply due to crop failure, lockouts, strikes, war, etc. A price rise in such condition is not considered to be a sustainable increase in the general price level.
- The rise in the price after depression or recession is not considered to be inflationary. Usually, the prices rise during the recovery stage to reach to their normal level. Thus, such a price rise is not inflation even if it is persistent or appreciable.
Thus, every time increase in the prices of goods and services is not considered to be inflationary and hence must be handled carefully while determining the position of the economy.