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Inflation Is a process that is ambiguously interpreted in the economy, in particular causes of inflation are the subject of debate and controversy for many economists. This is partly due to the fact that the inflation rate is influenced by many factors, as well as the negative consequences that inflation provokes in the socio-economic sphere.

Inflation is a prolonged rise in prices in the economy, which is accompanied by a fall in the purchasing power of money. That is, inflation leads to the depreciation of money, as a result of which for the same amount of money, over time, fewer goods and services can be purchased. Therefore, it is logical to conclude that inflation is “evil”. However, not everything is so simple.

Most economists agree that moderate inflation is a positive development for the economy, because stimulates consumption, which in turn contributes to the growth of production, and therefore has a positive effect on the parameters of GDP. In contrast to deflation, which all governments of the world are fighting against, hyperinflation is generally an extremely negative phenomenon, accompanied, as a rule, by an economic crisis.

For subjects of economic relations, inflation brings different opportunities: someone gets a loss, and someone benefits from it. Therefore, in society there will always be those who are looking for objective causes of inflation in order to justify inflationary policy, and those who condemn it.

Before investigating the causes of inflation, let s remember equation of money circulation (money exchange) Irving Fischer:

 M * V = Q * P

M – money supply (the amount of money in circulation);
V – the speed of circulation of a unit of money;
Q – the level of real production (the physical volume of goods in circulation);
R – the level of prices of goods

Based on this equation, we can distinguish 3 main causes of inflation (factors influencing the price level):

  1. an increase in the money supply;
  2. an increase in the speed of circulation of money;
  3. drop in real production (decrease in the number of manufactured goods).

It should be noted that a change in one of the parameters does not always lead to inflation, because factors can be mutually exclusive. For example, an increase in the money supply may be accompanied by an adequate increase in the production of goods, in which the equation of exchange will be maintained, i.e. there will be no rise in prices.

The main cause of inflation is an increase in the money supply

Based on data from economic observations, the main cause of inflation is the increase in the mass of money in circulation. What is the reason for this?

In the struggle to increase GNP growth and employment, governments in many countries often implement monetary stimulus policies, thereby increasing the money supply in the economy. According to monetarists, it is the excessive increase in the supply of money that is the key cause of inflation. money is becoming more accessible, which entails an increase in the rate of lending to the economy, an increase in the monetary income of subjects of economic relations and an increase in effective demand for goods.

Monetary policy to increase the supply of money is implemented by lowering the discount rate, lowering the required reserves, open market operations conducted by the country s central bank to buy back government bonds, etc. As a result, the money multiplier increases.

The increase in the amount of money in circulation also occurs when the issuing bank “turns on” the printing press. Often, the emission of money is due to the imbalance of the state budget, when expenditures exceed revenues, i.e. there is a budget deficit.

The second reason for inflation is an increase in the speed of circulation of money

The speed of circulation of money (all other things being equal) in the economy is relatively stable. However, during the period of inflationary expectations, the velocity of circulation begins to increase significantly, which provokes a rise in prices and an increase in inflation rates. Money becomes “hot”, enterprises and the population strive to direct the available free funds as quickly as possible for the purchase of goods (materials), thereby “heating up” the demand.

The third reason for inflation is the fall in real production

A fall in real production, while the money supply and the velocity of money circulation remain unchanged, inevitably leads to an increase in prices. A drop in production can occur under the influence of various factors, for example, due to the cyclical development of the economy, due to negative structural changes in the economy, political instability in the country, external economic sanctions, etc.

Other causes of inflation

In addition to the main ones, there are other (indirect) causes of inflation:

  • rise in prices in world markets for imported raw materials and goods, as a result of which national producers and trading companies are forced to raise the selling prices for their products (goods);
  • imbalances at the macroeconomic level between increases in wages and labor productivity;
  • monopolization of the economy, when the key sectors of the economy are controlled by monopolies that dictate monopoly prices;
  • an increase in the tax burden, as a result of which enterprises are forced to include an increase in certain types of taxes (excise taxes) in the sales price of products;
  • capital outflow from the country due to which investments in the national economy are reduced, which leads to a drop in production;
  • negative balance of trade, leading, as a rule, to the devaluation of the national currency and an increase in prices for imported goods, and subsequently – for the products of national producers;
  • macroeconomic imbalances between production and consumption, accumulation and consumption;
  • instability of the socio-political situation in the country, etc.

In order to keep inflation at an acceptable level, the government uses various methods of inflation regulation.

Post Author: Rachel Reinbauer

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