Stagflation poses a particularly daunting challenge to central banks because it increases the risks associated with fiscal and monetary policy responses. Whereas central banks can usually raise interest rates to combat high inflation, doing so in a period of stagflation could risk further increasing unemployment. Conversely, central banks are limited in their ability to decrease interest rates in times of stagflation because doing so could cause inflation to rise even further.
As such, stagflation acts as a kind of check-mate against central banks, leaving them with no moves left to make. Stagflation is arguably the most difficult type of inflation to manage. Also known as deflation , negative inflation occurs when prices drop for various reasons.
Having a smaller money supply increases the value of money, which in turn decreases prices. A reduction in demand either because there is too large of a supply or a reduction in consumer spending can also cause negative inflation.
Deflation may seem like a good thing because it reduces the prices of goods and services, thus making them more affordable, but it can negatively affect the economy in the long run. When businesses make less money on their products, they are forced to cut costs, which often means laying off or terminating employees, thereby increasing unemployment. We can define inflation with relative ease, but the question of what causes inflation is significantly more complex. Although numerous theories exist, arguably the two most influential schools of thought on inflation are those of Keynesian and monetarist economics.
Keynesian economists argue inflation results from economic pressures such as the increased cost of production and look to government intervention as a solution; monetarist economists believe inflation stems from the expansion of the money supply and that central banks should maintain stable growth for the money supply in line with GDP. The Keynesian school of thought derived its name and intellectual foundation from British economist John Maynard Keynes — As such, adherents of this tradition advocate government intervention through fiscal and monetary policy as a means of achieving desired economic outcomes, such as increasing employment or dampening the volatility of the business cycle.
The Keynesian school believes inflation results from economic pressures such as rising costs of production or increases in aggregate demand. Specifically, they distinguish between two broad types of inflation: cost-push inflation and demand-pull inflation.
Monetarism is not explicitly linked to a particular founding figure but is closely associated with the American economist, Milton Friedman — Specifically, it is concerned with the economic effects of changes to the money supply.
Adherents of the monetarist school are more skeptical than their Keynesian counterparts regarding the effectiveness of government intervention in the economy. Monetarists caution such interventions risk doing more harm than good.
Perhaps the most famous such criticism was made by Friedman himself in his influential publication co-written with Anna J. Schwartz , A Monetary History of the United States, , in which Friedman and Schwartz argued that policy decisions of the Federal Reserve inadvertently deepened the severity of the Great Depression.
Monetarists have historically explained inflation as a consequence of an expanding money supply. Instead, it is all about the supply of money. At the heart of this perspective is the quantity theory of money , which posits the relationship between the money supply and inflation is governed by the relationship. Implicit in this equation is the belief that if the velocity of money and the volume of transactions is constant, an increase or decrease in the supply of money will cause a corresponding increase or decrease in the average price level.
Given that the velocity of money and the volume of transactions are in reality never constant, it follows that this relationship is not as straightforward as it may initially seem. Inflation comes in many forms, from historically extreme cases of hyperinflation and stagflation to the five-cent and cent increases we hardly notice.
Economists from the Keynesian and monetarist schools disagree on the root causes of inflation, underscoring the fact that inflation is a far more complex phenomenon than one might initially assume. International Monetary Fund. Cato Journal. Accessed May 5, Bank of England. Federal Reserve History.
BBC History. The Nobel Prize Organization. Federal Reserve Bank of Cleveland. Download "PDF". Follow AllBankingSolutions. Rajesh Goyal. What is Inflation or What is the meaning of Inflation :. In economics inflation means, a rise in general level of prices of goods and services in a economy over a period of time. When the general price level rises, each unit of currency buys fewer goods and services. Thus, inflation results in loss of value of money. Another popular way of looking at inflation is "toomuch money chasing too few goods".
In case the price of say only one commodity rise sharply but prices of other commodities fall, it will not be termed as inflation. Similarly, in case due to rumors if the price of a commodity rise during the day itself, it will not be termed as inflation. What are different types of inflation :. Broadly speaking inflation is divided into two categoires i. The Power of the Business Cycle. What is Money? How Does the Futures Market Work? The Different Forms of Reflation. Understanding the Basics of the Options Market.
Deflation: The Good, the Bad, and the Ugly. What Really Causes Inflation? Examining Entry and Exit Points.
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