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side inflation. But Inflation can be divided into two broad types:
- Open inflation – when the general price level in an economy rises continuously and
- Repressed inflation – when the economy suffers from inflation without any apparent rise in
prices.According to Keynes, inflation is an imbalance between the aggregate demand and aggregate supply of goods and services. Therefore, if the aggregate demand exceeds the aggregate supply, then the prices keep rising.Causes of Inflation (a) Economic Causes In an economy, when the demand for a commodity exceeds its supply, then the excess demand pushes the price up. On the other hand, when the factor prices increase, the cost of production rises too. This leads to an increase in the price level as well.
(i) Increase in Public Spending In any modern economy, Government spending is an important element of the total spending. It is also an important determinant of aggregate demand.Usually, in less developed economies, the Govt. spending increases which invariably creates inflationary pressure on the economy.(ii) Deficit Financing of Government Spending There are times when the spending of Government increases beyond what taxation can finance.Therefore, in order to incur the extra expenditure, the Government resorts to deficit financing.For example, it prints more money and spends it. This, in turn, adds to inflationary pressure.(iii) Increased Velocity of Circulation In an economy, the total use of money = the money supply by the Government x the velocity of circulation of money.When an economy is going through a booming phase, people tend to spend money at a faster rate increasing the velocity of circulation of money.(iv) Population Growth As the population grows, it increases the total demand in the market. Further, excessive demand creates inflation.(v) Hoarding Hoarders are people or entities who stockpile commodities and do not release them to the market.Therefore, there is an artificially created excess demand in the economy. This also leads to inflation.(vi) Genuine Shortage It is possible that at certain times, the factors of production are short in supply. This affects production. Therefore, supply is less than the demand, leading to an increase in prices and inflation.(vii) Exports In an economy, the total production must fulfill the domestic as well as foreign demand. If it fails to meet these demands, then exports create inflation in the domestic economy.(viii) Trade Unions Trade Unions work in favor of the employees. As the prices increase, these unions demand an increase in wages for workers. This invariably increases the cost of production and leads to a further increase in prices.
(ix) Tax Reduction While taxes are known to increase with time, sometimes, Governments reduce taxes to gain popularity among people. The people are happy because they have more money in their hands.However, if the rate of production does not increase with a corresponding rate, then the excess cash in hand leads to inflation.(x) The imposition of Indirect Taxes Taxes are the primary source of revenue for a Government. Sometimes, Governments impose indirect taxes like excise duty, VAT, etc. on businesses.As these indirect taxes increase the total cost for the manufacturers and/or sellers, they increase the price of the product to have a minimal impact on their profits.(xi) Price-rise in the International Markets Some products require importing commodities or factors of production from the international markets like the United States. If these markets raise prices of these commodities or factors of production, then the overall production cost in Kenya increases too. This leads to inflation in the domestic market.
(b) Non-economic Reasons There are several non-economic factors which can cause inflation in an economy. For example, if there is a flood, then crops are destroyed. This reduces the supply of agricultural products leading to an increase in the prices of the commodities.
Quantity Theory of Money and Inflation There are two approaches to analyze the Quantity Theory of Money. These are Fisher’s Theory and Cash Balance Approach.Quantity Theory of Money Fisher’s theory explains the relationship between the money supply and price level. According to Fisher,
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