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It’s not surprising to hear the term economic inflation types of inflation in newsletters and economic analysis programs, and even in our daily conversations, since inflation is one of the most important economic terms of the 21st century, and one of the most important problems facing countries. So, what is inflation and how does it affect our lives and properties?
Defining Inflation or inflation meaning
inflation meaning
Economic inflation is when prices go up significantly, which causes an imbalance between the supply of commodities and the demand for cash, thus leading to undesirable price increases.
By that, I mean inflation affects the money supply so that its purchasing power decreases, and we as consumers are affected by the price of things we buy with the same amount of money. Let’s say we buy a car for five thousand dinars, then after inflation, we’ll buy the same car for eight thousand dinars.
What are the Causes of Economic Inflation?
Scholars were interested in studying and understanding economic inflation because of its importance and direct effects on human society. Thus, they came up with a few theories that explain inflation, as these theories explain inflation in a lot of ways.
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First: Demand-pull inflation
Inflation of this type occurs when the total demand exceeds the total supply, as the population wants to buy more products on the market, and producers aren’t able to meet the demand.
This will lead to price increases in the short term, and in response to price increases, trade unions will demand wage increases since the real value of wages has decreased, which will increase demand again, which will lead to price increases.
Second: Cost-Push Inflation
An increase in operating costs, such as energy prices, or increasing interest rates for financing, causes this type of inflation. Islamic economies appear to be less susceptible to this type of inflation since they forbid the fixed return on financing, as it makes financing a participant in the risk.
As production costs go up, the final product will cost more, and so will the price of everything. In this case, the professional unions are going to demand workers’ rights and raise wages, and since the workers’ wages are the main inputs to production, increasing wages are going to have an effect on the price of final products and on prices overall.
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Third: Profit – Push Inflation
According to this theory, economic inflation is caused by the market’s shift to a monopolistic structure, providing producers with a way to cover the average total cost while still making a profit. The only option for the consumer is to accept the price.
Monopoly also raises prices twice, once when the supply is constrained, so factories don’t operate at their full capacity, wasting energy. Basically, it’s the average total cost, and monopoly means the price rises because it gives the monopolist the power to decide how much profit he wants to make.
Fourth: Incoming Economic Inflation
According to this theory, economic inflation comes from the business partner’s economy. Commercial exposure (depending heavily on imports) means the economy is more vulnerable to inflation, and developing countries are more dependent on imports, so they’re more vulnerable.
Fifth: Structural Inflation
This type of inflation is caused by the actual demand being greater than the demand required to achieve full employment, so an increase in prices results from the economy not being able to increase production because it’s at its maximum capacity.
Sixth: Global Inflation
The global inflation phenomenon is one of the reasons inflations attract demand, since inflation became a global phenomenon after Bretton Woods, which made the dollar the leading global currency, and the Federal Reserve is a global central bank that controls liquidity. America’s excessive printing of the dollar to finance its wars led to an increase in commodities, which allowed them to steal from the value of the people’s currencies and enjoy the profits of money issuance. Global inflation is caused by this.
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Types of inflation
types of inflation
The three types of Inflation are Demand-Pull, Cost-Push, and Built-in inflation:
- Demand-pull Inflation: It happens when demand for goods or services is higher than supply. When demand and supply are different (shortage), prices go up.
- Cost-push Inflation: It happens when the cost of production goes up. Increased input prices (labor, raw materials, etc.) increase the price of the product.
- Built-in Inflation: The expectation of future inflation creates built-in inflation. A rise in prices means higher wages to cover the cost of living. Consequently, high wages increase production costs, which affects product pricing. The circle keeps going.
Effects of Economic Inflation
1- Distorts the distribution system and redistributes wealth in an absurd way, which benefits debtors and financial speculators and leads to concentration of wealth and middle-class extinction.
2- It reduces savings because people aren’t able to save, so more of their income will go to consumption.
3- It reduces investment since investment depends on saving, and since savings are reduced, the investment will go down.
It limits economic growth because it depends on productive capacity, which depends on real investment, so there are fewer opportunities for economic growth.
Five- Inflation creates hatred between communities because of administrative and financial corruption.
6- It violates the economic community’s objectives, like fair distribution, efficiency, stability, and growth, and that’s bad for society.
Seven- Violations of long-term contracts, like forwarding sales, good loans, and selling by installments, which limit the economy’s ability to expand.
Reduced exports because of high production costs, which hurts their ability to compete in global markets.
Curing Economic Inflation
We can deal with demand-pull inflation with monetary policy, by raising the legal reserve ratio, raising interest rates when borrowing, and raising the price of securities in banks.
Second: Using fiscal policy to curb inflation, which means raising taxes or imposing new taxes, reducing government spending, and borrowing to shrink the money supply.
Third: Using a policy to reduce demand attraction, like fixing or managing commodity prices. Putting a price on energy and wages to reduce demand-pull inflation.
A fourth way to deal with inflation is with monetary policy since the central bank monopolizes monetary issuance and controls inflation.
Chances of Economic inflation occurring in an Islamic economy
According to the followers of Islamic economic doctrine, an Islamic economy is less likely to have inflation than other economies, so why do they believe that?
1- Riba is prohibited, which limits the opportunities for commercial banks to generate money because the central bank is the only one that can manage the money supply proportionate to the commodity supply.
2- Riba prohibition removes barriers to real investment, which increases commodity supply.
3. The prohibition of monopoly protects society from excessive monopoly power, weakens the power of the monopolist, and increases the supply of commodities.
4- Zakat encourages investment since the investor wants to make a profit so he can pay zakat and not the capital itself, and thus increases supply.
5- Preventing money speculation leads to monetary stability and helps money function.
Source: The Boomoney
