Today inflation has become the common problem of the world and almost every one talks about the root causes of inflation. It is clear that inflation is a matter of raising prices when the supply of goods and services is low than the demand for such items starts increasing. The increase in pricing is probably due to the increase in the supply of money than the production of goods and services. Thus it leads to inflation in the country. Increase in the supply of money is not only the single cause of inflation, there are a lot more causes of inflation, which directly or indirectly impact the prices.
Money supply refers to legal tender and credit money. The increase in volume of money does not increase the production at the same rate. When the rate of production remains behind, there is inflation. It is also a state of inflation when costs are not falling but remain the same.
According to K.P.Kent, “Inflation is nothing more than a sharp upward movement in the price level”.
According to W.A.L Colborne, “Inflation means “Too much money chasing too few goods”.
According to A.C Pigou, “Inflation exists when money income is expanding more than in proportion to income earning activities”.
Along with the supply of money, there are a lot more causes of inflations, let’s talk about the causes of inflation, which put a bad impact on the overall economy.
Root Causes of Inflation
The main causes of inflation are discuses as under”-
- Policy of Deficit Financing
When the govt expenditure exceeds its revenue, it is known as deficit financing. Generally third world countries maintain a deficit budget for the growth of economy in the country. Deficit financing is for the purpose of meeting the additional expenditure in the deficit budget. As a result the supply of money in the economy increases along with its velocity and naturally credit money and its velocity rises as well. Thus rise of credit money in the market lead to increase in prices and become the root cause of inflation.
- Increase in Non- Development Expenditure
This is particularly the case when defense is concerned with exception to the USA. General countries especially those situated in war zone areas e.g. the Middle East have to spend a target amount of their financial resources on defense. Such expenses also from the root causes of inflation, govt should be careful in this regards to while spending money on such areas.
- Increases in Consumption Expenditure
A country may be in spite of the state of its economy, if it is in a consumption based society. Probably out of tradition, people of the country rich or poor, tend to consume more than they ought too.
- Labor Policy
Generally labor in third world countries are said to be less efficient as compared to their western counterparts. On the whole the marginal productivity of third world countries labors is very low as compared to the cost of production. Furthermore, to a certain extent there is misappropriating use of trade union, which supposedly exists to benefit the employees as well as the country in general. All this inefficiency leads to inflation and considered as the root causes of inflation in the third world countries.
- Growth of Population
Increase or growth in population is always showing a tremendous increase in the demand for goods and services, which lead to increase in pricing and thus to inflation. Too much population or excessive growth of population in any country of the world may lead to inflation, we should be careful in this regards.
- Devaluation of Currency
This means to lower down the exchange rate in comparison with an international currency. When the value of the home currency is low, imports of goods and services become expensive. These imports are used as factors of production in the agricultural and industrial sector. Hence the cost in production goes up and obviously the general price level goes up as well.
- Political instability
This would mainly affect the private sector as they are considered to be major contributors towards the growth of the economy. If there is unpredictability in the political situation of a country, entrepreneurs become reluctant to invest. Furthermore such would keep foreign investor well away. As a result there is a shortage of supply of goods and services, prices go up and inflation takes place.
- Undesirable Activities
Black marketing, smuggling, hoarding etc are such undesirable activities, which take place openly especially in third world countries. This hampers economic growth and lead to shortage of supply for domestic use and hence prices have to be increased. This is also from the root causes of inflation.
- Backward Agricultural and Industrial Sectors
Generally in large number of third world countries e.g. South America, Kampuchea etc the agricultural sector is not balanced in these countries in spite of vast natural resources. There is no proper equipment to increase the production, so there is a considerable wastage of resources in the agricultural and industrial sector, which also lead to inflation.
- Long term Development
Construction of long term projects e.g. building of dams generally takes more than 10 years to complete. The main thing to understanding is that until these long term projects are not successfully completed in the country, it does not get any return. Moreover when these projects get completed, first they recover the expenses they paid for these projects. So such long term projects also lead to inflation as they covered lot money every year.