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The process by which price of goods and services tends to rise while purchasing power of the currency falls is known as inflation. Central bank always tries to avoid deflation and limit inflation. This helps economy to run smoothly.
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What is monetarism and how does it explain the causes of inflation?
Monetarism tries to explain theoretically that inflation is related to money supply in an economy. For example, Aztec and Inca empires were conquered by Spain and after this conquest there was a huge amount of both silver and gold that flowed into European and Spanish economies. This incident led to an increase in the supply of money and a decrease in the value of money which finally led to a collapse in economy.
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What is Creeping inflation?
If prices of goods or services rise by 3 percent in a year then it is referred to as creeping inflation. Federal Reserve states that if prices of goods and services increases less than 2 percent a year then it helps in economic growth. This type of inflations makes consumers feel that prices of goods and services will continue to rise.
It also helps in boosting the demand of such products or services. Consumers start buying goods and services in order to prevent paying higher amount of money for the same goods and services in future. This is how economic expansion is able to drive inflation. Federal Reserve has therefore set 2 percent as the target for inflation.
Causes of Inflation
There are two kinds of inflation, one is cost pull inflation and the other is demand pull inflation. Both these types of inflation tend to increase the price of products and services within an economy.
When there is a rise in production process inputs then cost pull inflation occurs. The rising prices of raw materials and increase in wages are mostly the result of cost pull inflation. Demand pull inflation tends to increase if demand for goods and services rises more than the productive capacity of an economy.
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