For a layman, inflation means a substantial and rapid increase in the general price level which causes a decline in the purchasing power of money. Inflation is statistically measured in terms of percentage increase in the price index per unit of tune (usually a year or a month). There is no generally accepted definition of inflation and different economists define it differently.
Broadly, the phenomenon of inflation has been understood in three ways:
- in common view,
- in the Keynesian sense and
- in the modern sense.
Generally, inflation has been defined either (a) as a phenomenon of rising prices, or (b) as a monetary phenomenon:
1. As a phenomenon of Rising Prices:
Definitions given by the economists like Crowther, Gardner Ackley, and H.G. Johnson regard inflation as a phenomenon of rising prices. According to Crowther, inflation is a "state in which the value of money is falling, i.e., the prices are rising." In the words of Gardner Ackley, "Inflation is a persistent and appreciable rise in the general level or average of prices." Harry G. Johnson states, "I define inflation as substantial rise in prices."
2. As a Monetary Phenomenon:
Economists like Friedman, Coulborn, Hawtrey, Kemmerer, define inflation as a monetary phenomenon. According to Friedman, "Inflation is always and everywhere a monetary phenomenon." Coulborn defines inflation as "too much money chasing too few goods." Hawtrey defines inflation as the "issue of too much currency." According to Kemmerer, "Inflation is too much money and deposit currency, that is, too much currency in relation to the physical volume of business being done."
Keynes defined inflation as a phenomenon of full employment. According to him, inflation is the result of the excess of aggregate demand over the available aggregate supply and true inflation starts only after full employment. So long, there is unemployment, employment will change in the same proportion as the quantity of money and when there is full employment, prices will change in the same proportion as the quantity of money.
Keynes does not deny that prices may rise even before full employment, mainly due to the existence of certain bottlenecks in the expansion of output. However, he termed such a rise in prices as semi-inflation. It is the true inflation (after full employment), which poses a real threat to the economy and is to be worried about.
Modern economists analyze inflation in a comprehensive and unified manner. The modern view of inflation can be summarized in the following way:
(i) Generally, two types of inflation are distinguished: demand-pull inflation and cost push inflation. In the demand-pull inflation, inflation and falling unemployment are supposed to go together, while in cost-push inflation, inflation and rising unemployment are supposed to occur simultaneously.
(ii) During late 1950's A.W. Phillips empirically supported the idea that there existed a permanent long-run trade off between inflation and unemployment which implied that less inflation meant more unemployment and less unemployment would coexist with a higher rate of inflation.
(iii) In the late 1960's the monetarists held the view that the tradeoff between inflation and unemployment existed only in the short-run and not in the long-run. In the long-run when anticipated inflation is equal to actual inflation, inflation and unemployment will simultaneously increase.
(iv) The monetarists, like Friedman, Phelps. Leijonhufvud, also combined demand-pull and cost-push inflation as one integrated completely. According to them, inflation is a unified phenomenon on which demands and cost elements appear as a part of one integrated cycle and in which expectations of future price level movements play a prominent role.