STRUCTURAL THEORY OF INFLATION

Prof. Prabha Panth,Osmania University,

Hyderabad

Prabha Panth 2

Structural theory of inflation

• Myrdal and Streeten have contributed to this theory of inflation.

• To explain inflation in less developed countries, especially Latin America.

• Structural defects exist in less developed countries,

• Therefore the traditional QTM does not apply to less developed countries.

Prabha Panth 3

Structure of Less developed countries

1. Market imperfections,2. Structural rigidities,3. Under utilisation of resources,4. Unemployment,5. Lack of demand,6. Non monetised sectors,7. Unorganised sectors

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Bottlenecks in less developed countries

• Sectoral bottlenecks create imbalances that lead to rise in prices.

• It is necessary to study these imbalances to understand inflation in under developed countries.

• These bottlenecks arise in the process of economic development.

• So inflation has to be understood in the context of these structural imbalances.

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• There are three types of bottlenecks:1. Agricultural bottlenecks: food grain production

cannot increase due to bottlenecks in agriculture.So agricultural output is inelastic to rising incomes.

Bottlenecks in agriculture include:a) Disparities in land ownership and defective land tenure system.b) Use of backward agricultural technology.c) Lack of knowledge and access to finance.

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2. Government’s Resource constraints:• Infrastructure, Heavy industry, and Basic

industries have to be started in less developed countries.

• Mostly by Public sector.• Government may not have enough funds

to invest in such projects.• Therefore it prints money to pay for them.• This leads to inflation.

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• Prof. Gautam Mathur (1975) calls such investments as “Inflation Creating Activities”

• To reduce prices, equal investment in production of food grains and other necessaries is required.

• These are known as “Inflation Dampening Activities.

• Mathur calls the balance between Inflation Creating and Inflation Dampening activities as “The Balanced Allocation Ratio.”

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3. Foreign Exchange Bottlenecks:• Less developed countries have shortage

of foreign exchange.• Exports earnings are low, but import

payments are high.• To encourage exports, government

devalues currency,• This increases local prices, as well as

prices of imports.• Leading to inflation.

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• Hence traditional measures to control inflation will not work.

• Merely reducing the supply of money will not reduce prices.

• Controlling demand also will not work, as in Ldcs employment is rising due to economic growth.

• There is mismatch between demand and supply of goods.

• Investment in necessary consumer goods is required to lower prices.