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Modern Theories of Inflation

Definition: The Modern Theories of Inflation follows the theory of price determination. This means the general price level can be determined by aggregate demand and aggregate supply of goods and services. The variations in the general price level are caused by a shift in the aggregate demand and aggregate supply curves.

The modern theories of inflation are in fact the blend of classical and Keynesian theories of inflation. The classical theory laid emphasis on the role of money, i.e., the price rises in proportion to the supply of money, and ignored the non-monetary factors affecting inflation. While, the Keynesian theory laid emphasis on the non-monetary factors, i.e. aggregate demand in the real terms and ignored the effect of monetary expansion (money supply) on the price level.

The modern theories of inflation show that the price level is influenced by one or both of the demand-side and the supply-side factors. The factors which are functional on the demand side are called as the demand-pull factors, and those who operate on the supply-side factors are called as cost-push factors. Thus, there are two types of inflation:

  1. Demand-pull Inflation
  2. Cost-push Inflation

Note: A set of economists argues that the interaction between Demand-pull and cost-push factors cause inflation.

The modern theories of inflation play a vital role in formulating the anti-inflationary policy

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