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Definition:

 Inflation can be defined as a sustained or continuous rise in the general price level or, alternatively, as a sustained or continuous fall in the value of money.

or

Inflation is an increase in the quantity of money and credit. Its chief consequence is soaring prices. Therefore inflation—if we misuse the term to mean the rising prices themselves—is caused solely by printing more money. For this the government’s monetary policies are entirely responsible.

or

Inflation is the increase in the supply of money and credit. ”A substantial rise of prices caused by an undue expansion in paper money or bank credit.”

The word “inflation” originally applied solely to the quantity of money. It meant that the volume of money was inflated, blown up, overextended.

Reason for inflation:

The most frequent reason for printing more money is the existence of an unbalanced budget. Unbalanced budgets are caused by extravagant expenditures which the government is unwilling or unable to pay for by raising corresponding tax revenues. The excessive expenditures are mainly the result of government efforts to redistribute wealth and income—in short, to force the productive to support the unproductive. This erodes the working incentives of both the productive and the unproductive.

Fiscal Policy

Fiscal Policy – Government spending policies that influence macroeconomic conditions, undertaken by the government Manipulation of supply and/or demand by the federal government in an attempt to move the economy in the direction deemed to be most appropriate at that time. Fiscal policy refers to the overall effect of the budget outcome on economic activity. 

Fiscal Policy Instruments:

• Government Purchases (G)

• Transfer Payments (Tr)

• Taxes (T)

Monetary Policy is the strategy chosen by a government in deciding expansion or contraction in the country’s money-supply. Actions applied usually through central bank, currency board or other regulatory committee that determine the size and rate of growth of the money supply, which in turn affects interest rates

A monetary policy employs three major tools:

(1) Buying or selling national debt

(2) Changing credit restrictions,

(3) Changing the interest rates by changing reserve requirements.

Monetary policy plays the dominant role in control of the aggregate-demand and, by extension, of inflation in an economy.

Monetary policy can be classified as

i)                    Contractionary Monetary Policy

 Is when the Federal Reserve is using its tools to put the brakes on the economy to prevent inflation. This usually means raising the Fed Funds rate to decrease the money supply

ii)                   Expansionary monetary policy

Is when the Federal Reserve is using its tools to stimulate the economy. This usually means lowering the Fed Funds rate to increase the money supply.

If the Federal Reserve is lowering interest rates, it is drawing favorable attention in expansionary monetary policy