Analysis of factors affecting inflation rate in Rwanda (1990-2009)

CHAPTER TWO: LITERATURE REVIEW

2.1 DEFINITION OF KEY CONCEPTS

The concept is a prerequisite for any research. To avoid using vague terms and to fight against any kind of ambiguity, it is important to begin by defining the details of the key concepts of the study. The concepts defined in this study are: Inflation, Consumer Price Index, Gross Domestic Product, Interest Rate, Money Supply, Exchange rate.

2.1.1 Inflation

In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time. Moreover different economists have defined inflation as follows: According to the Kumar (1993:258) «inflation refers to the persistent, steady and continuous rise in the general prices of all outputs as well as inputs».

G. Crowther defines inflation as «a stage in which value of money is falling i.e. prices are rising.» Thus, inflation does not refer to the rise of price of one or two commodities, but the general rise in prices of all goods.

Prof. Coulburn has defined inflation as «too much money chasing too few goods» (Kumar and Mittal 2002:168).

According to Peterson (1977: 294) popularly inflation refers to the «sustained rise in the general price level and is generally measured by changes in the consumer price index».

A. Different types of inflation

According to the Kurman (1993: 260) Inflation has been divided into many kinds on the basis of different criteria like (1) Speed of inflation, (2) cause of inflation, (3) Control etc.

a. Creeping, Walking, Running and Galloping inflation: on the basis of rapidity of the rise in the prices inflation has divided into 4 types: creeping, walking, running and galloping inflation. However the different between these types of inflation is rather matter of degree only. Different names are given to different speed of price-rise.

When the price rises very slowly by about 3%, we call it creeping inflation, it is very mild and does not cause any harm to the economy. During walking inflation the rise in prices becomes more marked and it gives the danger signal of the occurrence of running inflation. When the prices increase by more than (say 10%) per annum, there is running inflation, which causes great harm to the economy. Running inflation gives rise to the galloping inflation, which is also known as jumping or hyper-inflation. During this situation, there is acute shortage of goods and extra ordinary expansion of currency and credit and it is very alarming and has disastrous consequences.

b. Demand-pull and Cost-push inflation: On the basis of cause of inflation, it has been divided into two types: Demand-pull inflation and Cost-push inflation. Demand-pull inflation is one kind of inflation which is caused by the excess demand for goods and services. This inflation takes place when the general prices rise as a result of growing demand for goods and services in relation to their supply.

On the other hand cost-push inflation refers to the situation of steady rise in prices which are mainly caused by the continuous rise in the cost of production of goods and services. It is the most important and popular type of inflation in developing countries. The cost of production of the producers rises continuously. Higher cost leads to higher prices always.

If the prices rise only due to higher wages then we call it «wage-induced» inflation. In other words the wage induced inflation occurs when the money wage rises faster than the labour productivity. Sometimes cost-push inflation becomes «profit-push» inflation, when the monopoly producers charge higher prices and enjoy higher profit margins.

c. Open inflation and suppressed inflation: open inflation refers to the unrestricted price-rise. When prices rise continuously and substantially, without any regulation, the phenomenon is called `open' inflation. During this inflation, the increase in demand directly leads to the ever increasing prices.

However, open inflation does not occur nowadays. No government allows such situation to take place. There are always some regulatory methods adopted by the governments to control the rise in price.

On the other hand, Suppressed inflation is regulatory inflation, known as latent inflation. The control measures sometimes may succeed for a short period. But in the long run the suppressed inflation may become uncontrollable and become open or hyper.

d. Imported inflation: Inflation due to increases in the prices of imports, increases in the prices of imported final products directly affect any expenditure-based measure of inflation. Increases in the prices of imported fuels, materials, and components increase domestic costs of production, and lead to increases in the prices of domestically produced goods. Imported inflation may be set off by foreign price increases, or by depreciation of a country's exchange rate.