Causes and Theories of Inflation

Published: 2021-09-15 16:20:10
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In the first hand, historically there were many schools that thought the causes of inflation. They were divided into two groups: the quality theories of inflation and the quantity theories of inflation.
The quality theory of inflation refers to the expectation of a seller to accept the currency in order to be able to exchange that currency at a later time for goods that are wanted as a buyer. While the quantity theory refers to the quantity equation of money that is connected to the money supply, the velocity and the nominal value of exchanges. The Keynesian view of inflation causes, states that the changes in the money supply do not affect the prices, and that inflation is the result of pressures in the economy. Three types of inflation are known, according to Robert J. Gordon, and they are referred as the “triangle model”. The first one is called the demand-pull inflation and it is known to occur when aggregate demand in the economy is larger than the aggregate supply. It happens as the inflation rises at the same time as the unemployment falls and the real gross domestic product (GDP) rises and, as the economy moves along the Phillips curve, which is a single equation empirical model which is describing how rates of unemployment and rates of inflation occurring in the economy are historically connected. This is almost always seen as “too much money chasing too few goods”, but it should be seen as involving “too much money spent chasing too few goods”, because the only money that gets spent on goods and services can result inflation. This would not be expected to happen, unless the economy is already at a full employment level. This happens in the Keynesian theory as increased employment happens as a result to increased aggregate demand which leads to hiring more firm in order for the output to get increased. Due to capacity constraints, the increase in output would eventually become so small that the prices of good will grow. It states that “At first, unemployment will go down, shifting AD1 to AD2, which increases demand (noted as “Y”) by (Y2 − Y1). This increase in demand means more workers are needed, and then AD will be shifted from AD2 to AD3, but this time much less is produced than in the previous shift, but the price level has risen from P2 to P3, a much higher increase in price than in the previous shift.” This increase in price is referred to as inflation. The second one is known as the cost push inflation, and it is a type of inflation that is caused by increases in the cost of goods and services, in which no alternative is available. One example is the oil crises that occurred in the 1970s, are the major cause of the inflation that happened in the Western world that particular decade.This inflation can be seen as a result from the increase in the cost of petroleum appointed by the member states of OPEC. A large increase in petroleum price can be connected to the increase in the price of most of the products. Such a change in the price level can increase the inflation rate over longer periods, because of adaptive expectations and the price/wage spiral, in order for the supply shock to have persistent effects. The third one is called built in inflation, and it happens as a result from past events and still occurs in the present. It mostly results from wither persistent demand pull or large cost push inflation which happened in the past.
Inflammatory expectations occur, since workers and employers may be expecting a large increase of the prices in the future, and because of that they increase their wages and prices in the present. This means that inflation happens because of some view about what might happen in the future. If one follows the accustomed accepted theory of adaptive expectations, inflationary expectations will occur due to some past experience with inflation.
This price/wage spiral refers to the adversarial nature of the wage bargain in modern capitalism. Workers and employers never agree together on the value of their wages. Instead, workers try to protect their real wages by trying to get higher wages. The cost that faces the employers will be raised, if they are successful. So, in order to protect the real value of their profits, employers put the higher cost on the consumers as higher prices. This is what encourages the workers to try to get higher money wages.

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