Causes of Inflation

Inflation is a situation where general price level is rising continuously indicating disequilibrium between demand and supply of goods at current prices. Causes of inflation vary from one country to another, thus different types of inflation exist at different places depending upon the reasons which generate inflation. However there are some common causes of inflation among different countries which are given below.


  • Deficit Financing

The situation in which government expenditure exceeds its revenue is called deficit financing. The additional expenditure in the deficit budget is met by deficit financing.  Due to deficit financing the money supply in country increases but the production does not increase at the same rate therefore prices starts to rise and cause inflation.


  • Increase in Money Supply

Tremendous increase in money supply is also a cause of inflation. Money supply is increased due to different reasons such as lower bank rates, deficit financing, decrease in reserve ratio etc.  Due to increase in money supply the amount of cash with people and banks is increased. Therefore commercial banks will provide more loans to the people at lower rates of interest and on the other hand people will demand more goods and services because of availability of cash. Due to increase in demand for goods and services, prices start to rise and thus cause inflation.


  • Increase in Developmental and Non-Developmental Expenditures

The developmental and non-developmental expenditures of government also lead to the inflation. For example non developmental expenditures such as expenditure on defense, government official’s foreign tours, increase in salaries of government employees etc leads the economy of an inflationary situation.  On the other hand in most developmental projects output starts many years after the money has been spent. Such type of developmental projects is also a source of inflation.


  • Population Explosion

Rapid increase in population is also an important cause of inflation. With the increase in population demand for goods and services also increases but supply does not increase at the same rate. Due to imbalance between demand and supply of goods and services, prices start to rise and cause inflation.


  • Devaluation of Currency

Devaluation of currency refers to decrease in external value of currency by monetary authorities through an official order. When the local currency is devalued against foreign currency then the prices of imported goods will increase. These imported goods are used in various factors of production and will ultimately increase the cost of production. Due to increase in cost of production the prices start to increase and cause inflation. Such type of inflation is called cost push inflation.


  • Political instability

Political stability is very important for the economic development of a country. Political stability discourages speculation and hording and encourages investment. If there is an unpredictable turn in the political situation of a country entrepreneurs become reluctant to invest. Similarly foreign investors do not invest whereas industrialists and businessmen feel insecure and cannot make good plans. Due to which shortage of goods and services occur and cause inflation.


  • Undesirable Activities

Various illegal activities such as smuggling, black marketing, hording etc hamper the economic growth and causes shortage of supply for domestic use. In case of hording frequently artificial scarcity of essential items is created and huge profits are charged. Here it should be noted that the income from such sources is not used on productive activities rather it is carelessly spent on luxury items, jewelry, speculation, consumer goods etc. Due to higher spending, the demand for goods and services increases and thus causes inflation.

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