Inflationary Process and its Control in less developed countries

Abstract

The inflationary process assumes so many different complexions at different times and in different countries that it is doubtful whether we can ever have an all-embracing theory of inflation equally applicable in all circumstances. Earlier theories of inflation were almost invariably theories of general excess demand. The quantity theory typically proceeded from excess supply of money to a general rise in excess demand to a general rise in the price level. The Keynesian analysis cast doubt on monetary holdings as a dominant determinant of spending decisions, but retained the emphasis on aggregate excess demand as the crucial factor in the inflationary process. The post-Second World War experience of prices rising almost continuously in several economically advanced countries irrespective of the state of total demand gave rise to the ‘cost-push’ hypothesis, which attributes the rise in prices to autonomous upward shifts in the wage level. Another interesting variant is the theory of ‘mark-up inflation’, which claims that prices and wages are not determined in the instantaneous market clearing manner envisaged in the orthodox theory of prices, and advances the hypothesis that inflation proceeds by a cost mechanism in which prices are determined by applying a mark-up to costs, and wages are set with reference to some mark-up over the cost of living. A more recent development in the theory of inflation has been the thesis of ‘sectoral demand shift’, which attempts to show that prices may well rise even in the absence of overall excess demand on account of changes in the composition and structure of demand.

Even in advanced countries, it has been increasingly realised that Keynes overemphasised the influence of the quantity of money on the rate of interest and under-emphasised the direct effects of cash balances on effective demand. The position taken by Professor James S. Duesenberry, for example, is that ‘the rate of growth of money income is substantially influenced by the rate of growth of money supply even if it is true that the demand for money is elastic to the interest rate ...’. See his Business Cycles and Economic Growth (McGraw-Hill, 1958) pp. 317–30.