There is a great controversy over the question whether inflation promotes economic development. A group of economists including Keynes is of the opinion that inflation, in one form or the other, is a factor which helps economic growth.
Usually, two main arguments have been advanced in support of the view. Firstly, it is argued that inflation tends to redistribute income and wealth.
The redistributive effect of inflation is always in favour of profit-earning class, that is to say, it redistributes income always from the wage-recipient class towards the profit-recipient class in the community.
As a result, the saving ratio will increase because the marginal propensity to save of the profit ...view middle of the document...
Thus, government, in view of inadequate funds (in the form of taxation and borrowing), can raise funds through deficit budget by resorting to printing money and use it for development programmes.
Hence, it is argued that deficit financing for capital formation should not be condemned during war time since it would result in breaking a bottleneck and, ultimately in producing the consumer goods which would match the additional money incomes.
Prof. Lewis considers that inflation for the purpose of creating useful capital is often ultimately self-terminating, since, sooner or later, it is likely to cause an increased supply of real goods in the market.
In the case of a backward economy, it is also argued that, where investment habits are not fully developed, part of the current savings of the people is likely to be hoarded in the form of currency.
Thus, if the money does not exceed the saving currently hoarded, deficit financing need not be inflationary as it offsets private hoarding currency.
A majority of economists hold that inflation is a child of growth process. Some degree of inflation, it is thought, is probably unavoidable in the process of economic development.
At least, in the initial stages of development process, there will always be significant lags between increases in consumer's money incomes and the availability of consumption goods in the country so that a price rise, i.e. inflation, to some extent is inevitable.
Another group of economists, on the other hand, is of the view that inflation does not stimulate economic development but on the contrary, works as an inhibitory factor. Milton Friedman, for instance, totally disagrees with the policy of "development through inflation."
To him, there is not much substance in the arguments put forward in support of the view that inflation will tend to stimulate development through its redistributive effects.
Because, in a deliberate process of inflation, many people will know about it and will act so as to prevent the redistributive from taking place. For instance, if, in a policy of "development through inflation, the price rise is prescribed at the rate of 3 per cent per annum, everybody will adjust themselves to the announcement.
Thus in order to have the redistributive effects favourable to development, prices will have to be increased by a higher rate. Once people adjust even to this rate, a still higher rate of increasing prices will be needed and thus, there will be no limit."
Prof. Nurkse holds the view that "the success of inflation as an instrument of capital formation depends largely on the degree to which rise in prices is unforeseen and unexpected.
When a further rise in prices is expected and seems certain, the velocity of circulation of money increases, saving gives place to dis-saving and inflation loses its capital-forming power."
Moreover, inflation "invites development, if any, only through the manipulation of markets rather than efficient production." This...