Inflation - A Great Evil



Table of Contents

Introduction1

Scope of the Paper2

Discussion2

Central Banks Permit Moderate Inflation3

John Maynard Keynes3

Major Contributions4

Theory of Inflation5

Milton Freidman6

Theory of Inflation7

Milton Vs Keynes - Emprical Evidence10

Conclusion11

Inflation- A Great Evil

Introduction

Inflation is continuous and widespread growth of prices of goods and services and factors of production in an economy over time. The cause of inflation is not a simple matter because the overall rise in prices often becomes a complex mechanism circularly because of which it becomes difficult to determine the factors driving the price increase. This difficulty in determining the causes of inflation has been the driving force behind a number of different test theoretical explanations of inflationary processes. Inflation is a very important aspect of the economy, as some of the most important economic disasters that have occurred in the world were due to uncontrolled inflation (also called hyperinflation).

The central bank has an important role to play with respect to inflation. It is an institution that in most countries serves as monetary authority which is usually responsible for the issuance of currency and overall design and implementation the monetary policy of the country to which it belongs. These banks are usually public, autonomous and independent of the government of the country (or countries) to which they belong. Escalating inflation is the main headache of central banks. Because it ultimately has the responsibility of controlling the money supply, the central bank should make every effort not to put in circulation a currency depreciated by inflation. To control inflation, central banks tend to increase the interest rate on the public debt. This increases the interest rates on consumer loans (credit cards, mortgages, etc). By increasing interest rates in consumption, demand for the products declines. The downside of this control is declining demand for products which as a result hampers the industry growth and can lead to economic stagnation and unemployment.

Scope of the Paper

Inflation, in economics, is the general increase in prices of goods and services relative to a currency held for a period of time. When the general price level rises, each unit of currency is enough to buy fewer goods and services. This means that inflation reflects the decreased purchasing power of money: a loss of real value in the internal medium of exchange and unit of measure of an economy.

The study aims to gauge the role of central banks with respect to inflation and discusses the views of the two most influential economists of the twentieth century John Maynard Keynes and Milton Friedman.

Discussion

Effects of inflation are different depending on whether it is anticipated (expected) or unexpected (unexpected). Under the conditions of expected inflation economic agents can build their behavior to minimize the magnitude of the fall in basic incomes and the depreciation of money. Thus workers expect an increase in the nominal wage rate and firms aim to provide higher prices for their products with expected inflation. Lenders are providing loans at nominal interest. Hence it is preplanned. In practice, the evolution of inflation is measures the changes in the Consumer Price Index (CPI). CPI is an indicator that measures the rate of change in ...