1. The phenomenon is not to be equated with the fact of high prices. It is a phenomenon of rising prices. It is a continuous fall in the purchasing power of money in absolute terms.

2. In an economy which uses money and credit and which operates under the guidance of market mechanism, some adjustment of individual prices is always going on in response to the dynamism of changing demand and supply forces. In other words, in such an economy, a continuous shift is taking place in relative prices. However, inflationary process is not the adjustment of individual prices, or relative prices. It is a process of continuous price rise in absolute terms, that is, a process of continuous fall in the purchasing power of money. The phenomenon of price rise is not restricted to only selected items. Its coverage keeps increasing and more and more prices start rising.

3. There is no absolute rate of price rise, which can be said to demarcate between inflationary and non-inflationary situations. This is because, by its very nature, an inflationary process is a continuous and cumulative one. Having started once, the rate of price rise keeps gathering momentum and is bound to exceed any prescribed rate. Unless we are able to check it through some means, the rate of price rise becomes so high that it leads to the collapse of the entire monetary system of the country.

4. As we have noted before, in a market economy, several individual prices are always under a process of adjustment in response to forces of demand and supply forces. In addition, there is a close input-output relationship between different categories of economic activities. In other words, when one price changes, there is generally an increase in input cost of several other economic activities which in turn leads to further price rise. The result is that it is possible for any individual price rise to become a cause for an inflationary process. We cannot keep an eye on only some selected prices and be sure that inflationary process would not start.


5. On account of input-output relations between different industries, inflationary process keeps increasing its coverage. With the passage of time, more and more prices are engulfed by it. It also leads to an increasing rate of price rise. It becomes a self-feeding cumulative process.

6. On account of close interaction between industries, we do not have any pre­determined set of causes and ‘effects’ of inflation. A given macro-variable alternatively becomes its cause and effect. For example, an increase in wage rate can result in an increase in production costs. Higher production costs can become the cause of higher prices, which in turn can become the cause of further rise in wages.

7. Higher prices necessitate a greater need for means of payment in the form of currency and credit. The authorities also require more funds to finance their activities. As a result, they increase the supply of currency. And at the same time, there is a greater generation of credit in the economy. However, increasing supply of money and credit helps in pushing prices further up, leading to the need for still additional supply of money and credit. Thus, a continuous increase in the supply of money and credit becomes an essential feature of inflation.

8. When inflationary process gains strength, it gives rise to expectations of further price rise. This increases the speed with which people spend their money balances.


9. When expectations of price rise become widespread, the suppliers develops tendency to hold back supplies, pile up stocks and create an artificial scarcity. They find that to hold back existing supplies is becoming increasingly more profitable than to produce fresh.

10. Price expectations also alter the asset preferences of the community. People prefer to hold more of non-monetary assets, which are expected to retain their ‘real’ purchasing power as against nominal money balances, which are continuously losing their purchasing power.

11. In the initial stages, there is an increase in interest rate because the lenders want to be compensated for the loss in the purchasing power of their loans. In later stages, however, money starts losing value so fast that the entire financial system may be disrupted and eventually collapses.

12. In the initial stages of inflation, the economy registers a growth in the output and employment along with an increase in prices. That is to say, rising prices provide an incentive to investors and producers in the form of higher expected profit. They are ready to invest more even in the face of rising rate of interest. However, in later stages of inflation.


(i) The phenomenon of increasing costs

(ii) Expectations of further rice rise

(iii) Other factors lead to a fall in real output and prices while there is an exponential growth in the supply of money.

13. Right from the beginning, there is a growing inequality in income distribution. Contractual incomes {like wages, interest, rent, etc.) lag behind while non- contractual and for residual incomes (like profit) increase in both absolute terms and as a proportion of the national income.


14. Inflation is the result of market imperfections. If the demand and supply flows are able to adjust themselves to changing prices without time lags, a persistent price rise cannot take place and inflationary process cannot come into existence.