They suggest that it is possible to reduce the natural rate of unemployment through labour market policies, whereby labour market can be made more efficient. But people with fixed incomes and those who are self-employed are unable to raise their prices and suffer a lot due to inflation. Friedman and other monetarists claim that inflation is predominantly a monetary phenomenon which implies that changes in velocity and output are small. This may happen if the costs of especially wage cost rise. That is, unanticipated inflation catches you by surprise.
Friedman does not give a new theory of how expectations are formed that would be free from theoretical and statistical bias. The rise in interest rate crowds out private investment. Such analysis is useful to study the distributional and other effects of inflation as well as to recommend anti-inflationary policies. In this way he has been able to prevent the erosion of his real income with the automatic revision of his money wage depending on the anticipated rate of inflation. Consequently, an artificial scarcity of commodities is created in the market.
On Saving In the short run, rising prices encourages people to deposit cash in hand with banks as money loses value so holding it does not much sense. This leads to the conclusion that a short run trade-off exists between unemployment and inflation, but there is no long run trade-off between the two unless a continuously rising inflation rate is tolerated. Recently, a Working Group was set up under chairmanship of Prof. Increase in Exports: When the demand for domestically produced goods increases in foreign countries, this raises the earnings of industries producing export commodities. The value of the inventories or stocks of goods and materials kept by the entrepreneurs and traders increases due to rise in prices of goods which brings about an increase in their profits.
In our opinion the above view of costs of inflation does not consider the true cost of inflation which, as mentioned above, refers to the reduction in purchasing power or real incomes of the people which lowers their standard of living. Thus tight monetary policy failed to check inflation despite 3. Industrial Disputes: In countries where trade unions are powerful, they also help in curtailing production. This will also put a check on private expenditure which is dependent upon government demand for goods and services. In a period of rising business activity when unemployment falls with increasing demand for labour, the employers will bid up wages. Look for cheaper alternatives to products that you normally buy. On Exchange Rate Rising prices generally leads to depreciation of the currency which implies that the currency loses its exchange value in front of a foreign currency.
Among these groups, the recipients of transfer payments belong to the lower income group and the rentier class to the upper income group. In many cases, their production such as steel, raw materials, etc. However, in the short run, like Keynesians, they believe that the economy may be working at less than full employment, that is, in the short run there may prevail excess capacity and unemployment of labour so that expansion in money supply and consequent increase in nominal income partly induces expansion in real income Y and partly results in rise in the price level as shown in Fig. In fact, this relation is a short-run phenomenon. Thus inflation redistributes wealth in favour of debtors.
This is because it is not possible to increase the supply of factors of production and hence of output after the level of full employment. At present in India, there is acute shortage of these infrastructural inputs which are hampering growth of output. To what extent price level increases depends upon the elasticity of supply or aggregate output in the short run. Structuralist Theory of Inflation : Structuralist theory, another important theory of inflation, is also known as structural theory of inflation and explains inflation in the developing countries in a slightly different way. Or inflation is attributed to budget deficit financing. Fiscal measures are highly effective for controlling government expenditure, personal consumption expenditure, and private and public investment.
Of the total direct government consumption expenditure, wages and salaries accounted for almost 50 per cent. Central banks throughout the world use monetary policy to control inflation. It can, thus, be viewed as the devaluing of the worth of money. Thus the inflationary gap leads to inflationary pressures in the economy which are the result of excess aggregate demand. Failure to anticipate inflation correctly leads to redistribution of income and wealth.
Basing his analysis on data for the United Kingdom, Phillips derived the empirical relationship that when unemployment is high, the rate of increase in money wage rates is low. Bondholders earn fixed interest income: These people suffer a reduction in real income when prices rise. When unemployment emerges there is a huge hue and cry by the workers who are rendered unemployed. As there is already full employment, the increase in money wages leads to proportionate rise in prices. The result is that the pressure of demand is such that it cannot be met by the currently available supply of output. However in the long run, rising prices depletes the saving rate in an economy. Keynes explained that inflation arises when there occurs an inflationary gap in the economy which comes to exist when aggregate demand for goods and services exceeds aggregate supply at full-employment level of output.