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Corporate Social Responsibility (CSR) – The

societal responsibility of companies


Bild: stock.xchng
The voluntary compliance of social and ecological responsibility of companies is
called Corporate Social Responsibility (CSR).

Corporate social responsibility is basically a concept whereby companies decide voluntarily

to contribute to a better society and a cleaner environment. Corporate social responsibility is
represented by the contributions undertaken by companies to society through its business
activities and its social investment. This is also to connect the Concept of sustainable
development to the company’s level.
Over the last years an increasing number of companies worldwide started promoting their
Corporate Social Responsibility strategies because the customers, the public and the
investors expect them to act sustainable as well as responsible. In most cases CSR is a
result of a variety of social, environmental and economic pressures.

The Term Corporate Social Responsibility is imprecise and its application differs. CSR can
not only refer to the compliance of human right standards, labor and social security
arrangements, but also to the fight against climate change, sustainable management of
natural resources and consumer protection.
The concept of Corporate Social Responsibility was first mentioned 1953 in the publication
‘Social Responsibilities of the Businessman’ by William J. Bowen. However, the term CSR
became only popular in the 1990s, when the German Betapharm, a generic pharmaceutical
company decided to implement CSR. The generic market is characterized by an
interchangeability of products. In 1997 a halt in sales growth led the company to the
realization that in the generic drugs market companies could not differentiate on price or
quality. This was the prelude for the company to adopt CSR as an expression of the
company’s values and as a part of its corporate strategies. By using strategic and social
commitment for families with chronically ill children children, Betapharm took a strategic

In July 2001, the European Commission decided to launch a consultative paper on

Corporate Social Responsibility with the title „Promoting a European Framework for
Corporate Social Responsibility“. This paper aimed to launch a debate on how the European
Union could promote Corporate Social Responsibility at both the European and international

The paper further aimed to promote CSR practices, to ensure the credibility of CSR claims
as well as to provide coherence in public policy on CSR.

Responsible Companies in the age of globalization

How a company perceives its societal responsibility depends on various factors such as the
markets in which it operates, its business line and its size.

In recent years CSR has become a fundamental business practice and has gained much
attention from the management of large international companies. They understand that a
strong CSR program is an essential element in achieving good business practices and
effective leadership. Companies have explored that their impact on the economic, social and
environmental sector directly affects their relationships with investors, employees and

Whilst so far Corporate Social Responsibility was mainly promoted by a number of large or
multinational companies, it is now also becoming important to small national companies.
»Teflon Companies«. Shell was one of first companies which made the experience, that
early responsible acting is better than later crisis management. Shell was taken by complete
surprise when the Greenpeace campaign against sinking the former drill platform Brent Spar
achieved its goals. There was a widespread boycott of Shell service stations. The Brent Spar
affair has brought quite some change of attitude to Shell.

As companies face themselves in the context of globalization, they are increasingly aware
that Corporate Social Responsibility can be of direct economic value. Although the prime
goal of a company is to generate profits, companies can at the same time contribute to social
and environmental objectives by integrating corporate social responsibility as a strategic
investment into their business strategy.

A number of companies with good social and environmental records indicate that CSR
activities can result in a better performance and can generate more profits and growth.
Research hast shown that company CSR programs influence to an extensive degree
consumer purchasing decisions, with many investors and employees also being swayed in
their choice of companies.

A major challenge for companies today is attracting and retaining skilled workers. There is
not only an image gain for the companies using CSR, but it is also important for the
employees. Within the company, socially responsible practices primarily involve employees
and relate to issues such as investing in human capital, health and safety and managing

In India there are an existent but small number of companies which practice CSR. This
engagement of the Indian economy concentrates mainly on a few old family owned
companies, and corporate giants such as the Tata and Birla group companies which have
led the way in making corporate social responsibility an intrinsic part of their business plans.
These companies have been deeply involved with social development initiatives in the
communities surrounding their facilities. Jamshedpur, one of the prominent cities in the
northeastern state of Bihar in India, is also known as Tata Nagar and stands out at a beacon
for other companies to follow. Jamshedpur was carved out from the jungle a century ago.
TATA’s CSR activities in Jamshedpur include the provision of full health and education
expenses for all employees and the management of schools and hospitals.
In spite of having such life size successful examples, CSR in India is in a very nascent
In the informal sector of the Indian economy, which contributes to almost the half of the GNP
and where approximately 93% of the Indian workforce is employed, the application of CSR is
rare. On the contrary, the fight against poverty, the development of education, as well as the
conservation of the environment are not existent in most of the Indian enterprises.
India has an advantage as far as labor is concerned. To some extent, business and capital
go to those places where costs are less or standards are lower like the ones in India. But
also in India, the demand for responsible and ethical goods is constantly increasing.

To guarantee the supply of responsible and ethical goods, it is especially important to

implement a nationwide system of CSR standards.

How "social responsible" are Companies in reality?

Due to the lack of international CSR guidelines, the practical application of CSR differs and
CSR Strategies within most companies still show major deficiencies. There are still
complaints about multinational companies wasting the environment and NGOs still
denouncing human rights abuses in companies. Some critics believe that CSR programs are
undertaken by especially multinational companies to distract the public from ethical
questions posed by their core operations. That meanwhile even multinational companies
such as Microsoft or Pepsi confess to their social responsibility, is discussed quite
While companies increasingly recognize their social responsibility, many of them have yet to
adopt management practices that reflect it: company employees and managers need training
in order to acquire the necessary skills and competence. Pioneering companies can help to
implement socially responsible practices by guiding the processes.

The Copenhagen Centre and CSR Europe have recently launched a program to bring the
business and academic community together with the aim to identify and address the training
needs of the business sector on Corporate Social Responsibility.

While corporate social responsibility can only be taken on by the companies themselves,
employees, consumers and investors can also play a decisive role in areas such as working
conditions, environment or human rights, in the purchasing of products from companies
which already adopted CSR or in prompting companies to adopt socially responsible

Critics suggest that better governmental and international regulation and enforcement, rather
than voluntary measures are necessary to ensure that companies behave in a socially
responsible manner.
Corporate social responsibility should therefore not be seen as a substitute to regulation
concerning social rights or environmental standards. In countries where such regulations do
not exist, efforts should focus on putting the proper regulatory framework in place on the
basis of which socially responsible practices can be developed.

From Wikipedia, the free encyclopedia

Globalization (or globalisation) describes the process by which regional economies, societies, and
cultures have become integrated through a global network of political ideas through communication,
transportation, and trade. The term is most closely associated with the term economic globalization:
the integration of national economies into the international economy through trade, foreign direct
investment,capital flows, migration, the spread of technology, and military presence.[1] However,
globalization is usually recognized as being driven by a combination of economic, technological,
sociocultural, political, and biological factors.[2] The term can also refer to the transnational circulation
of ideas, languages, or popular culture through acculturation. An aspect of the world which has gone
through the process can be said to be globalized.

Against this view, an alternative approach stresses how globalization has actually decreased inter-
cultural contacts while increasing the possibility of international and intra-national conflict.[3]

According to the Oxford English Dictionary, the word "globalization" was first employed in a
publication entitled Towards New Education in 1952, to denote a holistic view of human
experience in education.[4] An early description of globalization was penned by the founder of
theBible Student movement Charles Taze Russell who coined the term 'corporate giants' in 1897,
although it was not until the 1960s that the term began to be widely used by economists and
other social scientists. The term has since then achieved widespread use in the mainstream
press by the later half of the 1980s. Since its inception, the concept of globalization has inspired
numerous competing definitions and interpretations, with antecedents dating back to the great
movements of trade and empire across Asia and the Indian Ocean from the 15th century
The United Nations ESCWA says globalization "is a widely-used term that can be defined in a
number of different ways. When used in an economic context, it refers to the reduction and
removal of barriers between national borders in order to facilitate the flow of goods, capital,
services and labour... although considerable barriers remain to the flow of labor... Globalization is
not a new phenomenon. It began towards the end of the nineteenth century, but it slowed down
during the period from the start of the First World War until the third quarter of the twentieth
century. This slowdown can be attributed to the inward-looking policies pursued by a number of
countries in order to protect their respective industries... however, the pace of globalization picked
up rapidly during the fourth quarter of the twentieth century..."[7]

HSBC, the world's largest bank, operates across the globe.[8][9] Shown here is the HSBC Global Technology Centre
in Pune, India which develops software for the entire HSBC group.[10]

Tom G. Palmer of the Cato Institute defines globalization as "the diminution or elimination of
state-enforced restrictions on exchanges across borders and the increasingly integrated and
complex global system of production and exchange that has emerged as a result."[11]

Thomas L. Friedman has examined the impact of the "flattening" of the world, and argues
thatglobalized trade, outsourcing, supply-chaining, and political forces have changed the world
permanently, for both better and worse. He also argues that the pace of globalization is
quickening and will continue to have a growing impact on business organization and practice.[12]

Finally, Takis Fotopoulos argues that globalization is the result of systemic trends manifesting the
market economy's grow-or-die dynamic, following the rapid expansion of transnational
corporations. Because these trends have not been offset effectively by counter-tendencies that
could have emanated from trade-union action and other forms of political activity, the outcome
has been globalization. This is a multi-faceted and irreversible phenomenon within the system of
the market economy and it is expressed as: economic globalization, namely, the opening and
deregulation of commodity, capital and labour markets which led to the present form
of neoliberalglobalization; political globalization, i.e., the emergence of a transnational elite and
the phasing out of the all powerful nation-state of the statist period; cultural globalization, i.e., the
worldwide homogenisation of culture; ideological globalization; technological globalization; social

[edit]Effects summary
Globalization has various aspects which affect the world in several different ways

 Industrial – emergence of worldwide production markets and broader access to a range

of foreign products for consumers and companies. Particularly movement of material and
goods between and within national boundaries. International trade in manufactured goods
increased more than 100 times (from $95 billion to $12 trillion) in the 50 years since 1955.
China's trade with Africa rose sevenfold during 2000–07 alone.[15][16]
 Financial – emergence of worldwide financial markets and better access to external
financing for borrowers. By the early part of the 21st century more than $1.5 trillion in national
currencies were traded daily to support the expanded levels of trade and investment.[17]

As of 2005–2007, the Port of Shanghaiholds the title as the World's busiest port.[18][19][20]

 Economic – realization of a global common market, based on the freedom of exchange of

goods and capital.[21]
Almost all notable worldwide ITcompanies have a presence in India. Four Indians were among the world's top 10
richest in 2008, worth a combined $160 billion.[22] In 2007, China had 415,000 millionaires and India 123,000.[23]

 Job Market- competition in a global job market. In the past, the economic fate of workers
was tied to the fate of national economies. With the advent of the information age and
improvements in communication, this is no longer the case. Because workers compete in a
global market, wages are less dependent on the success or failure of individual economies.
This has had a major effect on wages and income distribution.[24]
 Political – some use "globalization" to mean the creation of a world government which
regulates the relationships among governments and guarantees the rights arising from social
and economic globalization.[25] Politically, the United States has enjoyed a position of power
among the world powers, in part because of its strong and wealthy economy. With the
influence of globalization and with the help of the United States’ own economy, the People's
Republic of China has experienced some tremendous growth within the past decade. If China
continues to grow at the rate projected by the trends, then it is very likely that in the next
twenty years, there will be a major reallocation of power among the world leaders. China will
have enough wealth, industry, and technology to rival the United States for the position of
leading world power.[26]

Among the political effects some scholars also name the transformation of sovereignty. In their
opinion, 'globalization contributes to the change and reduction of nomenclature and scope of
state sovereign powers, and besides it is a bilateral process: on the one hand, the factors are
strengthening that fairly undermine the countries' sovereignty, on the other – most states
voluntarily and deliberately limit the scope of their sovereignty'.[27]

 Informational – increase in information flows between geographically remote locations.

Arguably this is a technological change with the advent of fibre optic communications,
satellites, and increased availability of telephone and Internet.
 Language – the most spoken first language is Mandarin (845 million speakers) followed
bySpanish (329 million speakers) and English (328 million speakers).[28] However the most
popular second language is undoubtedly English, the "lingua franca" of globalization:
 About 35% of the world's mail, telexes, and cables are in English.
 Approximately 40% of the world's radio programs are in English.
 English is the dominant language on the Internet.[29]
 Competition – Survival in the new global business market calls for improved productivity
and increased competition. Due to the market becoming worldwide, companies in various
industries have to upgrade their products and use technology skilfully in order to face
increased competition.[30]
 Ecological – the advent of global environmental challenges that might be solved with
international cooperation, such as climate change, cross-boundary water and air pollution,
over-fishing of the ocean, and the spread of invasive species. Since many factories are built
in developing countries with less environmental regulation, globalism and free trade may
increase pollution and impact on precious fresh water resources(Hoekstra and Chapagain
2008).[31] On the other hand, economic development historically required a "dirty" industrial
stage, and it is argued that developing countries should not, via regulation, be prohibited from
increasing their standard of living.

London is a city of considerable diversity. As of 2008, estimates were published that stated that approximately 30%
of London's total population was from an ethnic minority group. The latest official figures show that in 2008,
590,000 people arrived to live in the UK whilst 427,000 left, meaning that net inward migration was 163,000.[32]

 Cultural – growth of cross-cultural contacts; advent of new categories

of consciousness and identities which embodies cultural diffusion, the desire to increase
one's standard of living and enjoy foreign products and ideas, adopt new technology and
practices, and participate in a "world culture".[33] Some bemoan the
resulting consumerism and loss of languages. Also seeTransformation of culture.
 Spreading of multiculturalism, and better individual access to cultural
diversity (e.g. through the export of Hollywood). Some consider such "imported" culture a
danger, since it may supplant the local culture, causing reduction in diversity or
even assimilation. Others consider multiculturalism to promote peace and understanding
between people. A third position that gained popularity is the notion that multiculturalism
to a new form of monoculture in which no distinctions exist and everyone shifts between
various lifestyles in terms of music, cloth and other aspects once more firmly attached to
a single culture. Thus not mere cultural assimilation as mentioned above but the
obliteration of culture as we know it today.[34][35] In reality, as it happens in countries like
the United Kingdom, Canada, Australia or New Zealand, people who always lived in their
native countries maintain their cultures without feeling forced by any reason to accept
another and are proud of it even when they're acceptive of immigrants, while people who
are newly arrived simply keep their own culture or part of it despite some minimum
amount of assimilation, although aspects of their culture often become a curiosity and a
daily aspect of the lives of the people of the welcoming countries.
 Greater international travel and tourism. WHO estimates that up to 500,000
people are on planes at any one time.[citation needed][36] In 2008, there were over 922 million
international tourist arrivals, with a growth of 1.9% as compared to 2007.[37]
 Greater immigration,[38] including illegal immigration.[39] The IOM estimates there
are more than 200 million migrants around the world today.[40] Newly available data show
that remittance flows to developing countries reached $328 billion in 2008.[41]
 Spread of local consumer products (e.g., food) to other countries (often adapted
to their culture).
 Worldwide fads and pop culture such as Pokémon, Sudoku, Numa
Numa, Origami, Idol series, YouTube, Orkut, Facebook, andMySpace; accessible only to
those who have Internet or Television, leaving out a substantial portion of the Earth's

The construction of continental hotels is a major consequence of globalization process in affiliation

with tourism and travel industry,Dariush Grand Hotel, Kish, Iran

 Worldwide sporting events such as FIFA World Cup and the Olympic Games.
 Incorporation of multinational corporations into new media. As the sponsors of
the All-Blacks rugby team, Adidas had created a parallel website with a downloadable
interactive rugby game for its fans to play and compete.[42]
 Social – development of the system of non-governmental organisations as main agents
of global public policy, including humanitarian aid and developmental efforts.[43]
 Technical
 Development of a Global Information System, global telecommunications
infrastructure and greater transborder data flow, using such technologies as
the Internet, communication satellites, submarine fiber optic cable, and wireless
 Increase in the number of standards applied globally; e.g., copyright
laws, patents and world trade agreements.
 Legal/Ethical
 The creation of the international criminal court and international justice
 Crime importation and raising awareness of global crime-fighting efforts and
 The emergence of Global administrative law.
 Religious
 The spread and increased interrelations of various religious groups, ideas, and
practices and their ideas of the meanings and values of particular spaces.[44]

What Is Globalization?

Globalization is a process of interaction and integration among the people, companies, and governments of different
nations, a process driven by international trade and investment and aided by information technology. This process
has effects on theenvironment, on culture, on political systems, on economic development and prosperity, and
on human physical well-being in societies around the world.
Globalization is not new, though. For thousands of years, people—and, later, corporations—have been buying from
and selling to each other in lands at great distances, such as through the famed Silk Road across Central Asia that
connected China and Europe during the Middle Ages. Likewise, for centuries, people and corporations have
invested in enterprises in other countries. In fact, many of the features of the current wave of globalization are
similar to those prevailing before the outbreak of the First World War in 1914.
Map of the Silk Road

But policy and technological developments of the past few decades have spurred increases in cross-border trade,
investment, and migration so large that many observers believe the world has entered a qualitatively new phase in
its economic development. Since 1950, for example, the volume of world trade has increased by 20 times, and from
just 1997 to 1999 flows of foreign investment nearly doubled, from $468 billion to $827 billion. Distinguishing this
current wave of globalization from earlier ones, author Thomas Friedman has said that today globalization is
“farther, faster, cheaper, and deeper.”
But policy and technological developments of the past few decades have spurred increases in cross-border trade,
investment, and migration so large that many observers believe the world has entered a qualitatively new phase in
its economic development. Since 1950, for example, the volume of world trade has increased by 20 times, and from
just 1997 to 1999 flows of foreign investment nearly doubled, from $468 billion to $827 billion. Distinguishing this
current wave of globalization from earlier ones, author Thomas Friedman has said that today globalization is
“farther, faster, cheaper, and deeper.”
This current wave of globalization has been driven by policies that have opened economies domestically and
internationally. In the years since the Second World War, and especially during the past two decades, many
governments have adopted free-market economic systems, vastly increasing their own productive potential and
creating myriad new opportunities for international trade and investment. Governments also have negotiated
dramatic reductions in barriers to commerce and have established international agreements to promote trade in
goods, services, and investment. Taking advantage of new opportunities in foreign markets, corporations have built
foreign factories and established production and marketing arrangements with foreign partners. A defining feature
of globalization, therefore, is an international industrial and financial business structure.
Technology has been the other principal driver of globalization. Advances in information technology, in particular,
have dramatically transformed economic life. Information technologies have given all sorts of individual economic
actors—consumers, investors, businesses—valuable new tools for identifying and pursuing economic opportunities,
including faster and more informed analyses of economic trends around the world, easy transfers of assets, and
collaboration with far-flung partners.
Globalization is deeply controversial, however. Proponents of globalization argue that it allows poor countries and
their citizens to develop economically and raise their standards of living, while opponents of globalization claim
that the creation of an unfettered international free market has benefited multinational corporations in the Western
world at the expense of local enterprises, local cultures, and common people. Resistance to globalization has
therefore taken shape both at a popular and at a governmental level as people and governments try to manage the
flow of capital, labor, goods, and ideas that constitute the current wave of globalization.
To find the right balance between benefits and costs associated with globalization, citizens of all nations need to
understand how globalization works and the policy choices facing them and their societies.
tries to provide an accurate analysis of the issues and controversies regarding globalization, without the slogans or
ideological biases generally found in discussions of the topics. We welcome you to our website.

From Wikipedia, the free encyclopedia
This article is about a rise in the general price level. For the expansion of the early universe,
see Inflation (cosmology). For other uses, see Inflation (disambiguation).

Inflation rates around the world in 2007


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Economy: concept and history

Business and Economics Portal
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In economics, inflation is a rise in the general level of prices of goods and services in
an economy over a period of time.[1] When the general price level rises, each unit of currency buys
fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of
money – a loss of real value in the internal medium of exchange and unit of account in the economy.[2]
A chief measure of price inflation is the inflation rate, the annualized percentage change in a
general price index (normally the Consumer Price Index) over time.[4]

Inflation's effects on an economy are various and can be simultaneously positive andnegative.
Negative effects of inflation include a decrease in the real value of money and other monetary items
over time, uncertainty over future inflation may discourage investment and savings, and high inflation
may lead to shortages of goods if consumers beginhoarding out of concern that prices will increase in
the future. Positive effects include ensuring central banks can adjust nominal interest rates (intended
to mitigate recessions),[5] and encouraging investment in non-monetary capital projects.

Economists generally agree that high rates of inflation and hyperinflation are caused by an excessive
growth of the money supply.[6] Views on which factors determine low to moderate rates of inflation are
more varied. Low or moderate inflation may be attributed to fluctuations in real demand for goods and
services, or changes in available supplies such as during scarcities, as well as to growth in the money
supply. However, the consensus view is that a long sustained period of inflation is caused by money
supply growing faster than the rate of economic growth.[7][8]

Today, most mainstream economists favor a low, steady rate of inflation.[9] Low (as opposed to zero
or negative) inflation may reduce the severity of economic recessions by enabling the labor market to
adjust more quickly in a downturn, and reduce the risk that a liquidity trap prevents monetary
policyfrom stabilizing the economy.[10] The task of keeping the rate of inflation low and stable is usually
given to monetary authorities. Generally, these monetary authorities are the central banks that control
the size of the money supply through the setting of interest rates, through open market operations, and
through the setting of banking reserve requirements.[11]


CPI inflation (year-on-year) in the United States from 1914 to 2010.


An increase in the general level of prices implies a decrease in the purchasing power of the
currency. That is, when the general level of prices rises, each monetary unit buys fewer goods
and services.[29] The effect of inflation is not distributed evenly in the economy, and as a
consequence there are hidden costs to some and benefits to others from this decrease in the
purchasing power of money. For example, with inflation, lenders or depositors who are paid a
fixed rate of interest on loans or deposits will lose purchasing power from their interest earnings,
while their borrowers benefit. Individuals or institutions with cash assets will experience a decline
in the purchasing power of their holdings. Increases in payments to workers and pensioners often
lag behind inflation, especially for those with fixed payments.[11]

Increases in the price level (inflation) erode the real value of money (the functional currency) and
other items with an underlying monetary nature (e.g. loans and bonds).
Debtors who have debts with a fixed nominal rate of interest will see a reduction in the "real"
interest rate as the inflation rate rises. The “real” interest on a loan is the nominal rate minus the
inflation rate (approximately [30] ). For example if you take a loan where the stated interest rate is
6% and the inflation rate is at 3%, the real interest rate that you are paying for the loan is 3%. It
would also hold true that if you had a loan at a fixed interest rate of 6% and the inflation rate
jumped to 20% you would have a real interest rate of -14%. Banks and other lenders adjust for
this inflation risk either by including an inflation premium in the costs of lending the money by
creating a higher initial stated interest rate or by setting the interest at a variable rate. As the rate
of inflation decreases, this has the opposite (negative) effect on borrowers.


High or unpredictable inflation rates are regarded as harmful to an overall economy. They add
inefficiencies in the market, and make it difficult for companies to budget or plan long-term.
Inflation can act as a drag on productivity as companies are forced to shift resources away from
products and services in order to focus on profit and losses from currency inflation.[11] Uncertainty
about the future purchasing power of money discourages investment and saving.[31] And inflation
can impose hidden tax increases, as inflated earnings push taxpayers into higher income tax
rates unless the tax brackets are indexed to inflation.

With high inflation, purchasing power is redistributed from those on fixed nominal incomes, such
as some pensioners whose pensions are not indexed to the price level, towards those with
variable incomes whose earnings may better keep pace with the inflation.[11] This redistribution of
purchasing power will also occur between international trading partners. Where fixed exchange
rates are imposed, higher inflation in one economy than another will cause the first economy's
exports to become more expensive and affect the balance of trade. There can also be negative
impacts to trade from an increased instability in currency exchange prices caused by
unpredictable inflation.

Cost-push inflation
High inflation can prompt employees to demand rapid wage increases, to keep up with
consumer prices. In the cost-push theory of inflation, rising wages in turn can help fuel
inflation. In the case of collective bargaining, wage growth will be set as a function of
inflationary expectations, which will be higher when inflation is high. This can cause
a wage spiral.[32] In a sense, inflation begets further inflationary expectations, which beget
further inflation.
People buy durable and/or non-perishable commodities and other goods as stores of
wealth, to avoid the losses expected from the declining purchasing power of money,
creating shortages of the hoarded goods.
Social unrest and revolts
Inflation can lead to massive demonstrations and revolutions. For example, inflation and
in particular food inflation is considered as one of the main reasons that caused 2010–
2011 Tunisian revolution [33] and Egyptian Revolution of 2011[34], according to many
observators including Robert Zoellick[35], president of the World Bank. Tunisian
president Zine El Abidine Ben Ali was ousted, Egyptian PresidentHosni Mubarak was
also ousted after only 18 days of demonstrations, and protests soon spread in many
countries of North Africa and Middle East.
If inflation gets totally out of control (in the upward direction), it can grossly interfere with
the normal workings of the economy, hurting its ability to supply goods. Hyperinflation
can lead to the abandonment of the use of the country's currency, leading to
the inefficiencies of barter.
Allocative efficiency
A change in the supply or demand for a good will normally cause its relative price to
change, signaling to buyers and sellers that they should re-allocate resources in
response to the new market conditions. But when prices are constantly changing due to
inflation, price changes due to genuine relative price signals are difficult to distinguish
from price changes due to general inflation, so agents are slow to respond to them. The
result is a loss of allocative efficiency.
Shoe leather cost
High inflation increases the opportunity cost of holding cash balances and can induce
people to hold a greater portion of their assets in interest paying accounts. However,
since cash is still needed in order to carry out transactions this means that more "trips to
the bank" are necessary in order to make withdrawals, proverbially wearing out the "shoe
leather" with each trip.
Menu costs
With high inflation, firms must change their prices often in order to keep up with
economy-wide changes. But often changing prices is itself a costly activity whether
explicitly, as with the need to print new menus, or implicitly.
Business cycles
According to the Austrian Business Cycle Theory, inflation sets off the business cycle.
Austrian economists hold this to be the most damaging effect of inflation. According to
Austrian theory, artificially low interest rates and the associated increase in the money
supply lead to reckless, speculative borrowing, resulting in clusters of malinvestments,
which eventually have to be liquidated as they become unsustainable.[36]
Labor-market adjustments
Keynesians believe that nominal wages are slow to adjust downwards. This can lead to
prolonged disequilibrium and high unemployment in the labor market. Since inflation
would lower the real wage if nominal wages are kept constant, Keynesians argue that
some inflation is good for the economy, as it would allow labor markets to reach
equilibrium faster.
Room to maneuver
The primary tools for controlling the money supply are the ability to set the discount rate,
the rate at which banks can borrow from the central bank, and open market
operations which are the central bank's interventions into the bonds market with the aim
of affecting the nominal interest rate. If an economy finds itself in a recession with already
low, or even zero, nominal interest rates, then the bank cannot cut these rates further
(since negative nominal interest rates are impossible) in order to stimulate the economy -
this situation is known as a liquidity trap. A moderate level of inflation tends to ensure that
nominal interest rates stay sufficiently above zero so that if the need arises the bank can
cut the nominal interest rate.
Mundell-Tobin effect
The Nobel laureate Robert Mundell noted that moderate inflation would induce savers to
substitute lending for some money holding as a means to finance future spending. That
substitution would cause market clearing real interest rates to fall.[37] The lower real rate
of interest would induce more borrowing to finance investment. In a similar vein, Nobel
laureate James Tobin noted that such inflation would cause businesses to substitute
investment in physical capital (plant, equipment, and inventories) for money balances in
their asset portfolios. That substitution would mean choosing the making of investments
with lower rates of real return. (The rates of return are lower because the investments
with higher rates of return were already being made before.)[38] The two related effects
are known as theMundell-Tobin effect. Unless the economy is already overinvesting
according to models of economic growth theory, that extra investment resulting from the
effect would be seen as positive.
Instability with Deflation
Economist S.C. Tsaing noted that once substantial deflation is expected, two important
effects will appear; both a result of money holding substituting for lending as a vehicle for
saving.[39] The first was that continually falling prices and the resulting incentive to hoard
money will cause instability resulting from the likely increasing fear, while money hoards
grow in value, that the value of those hoards are at risk, as people realize that a
movement to trade those money hoards for real goods and assets will quickly drive those
prices up. Any movement to spend those hoards "once started would become a
tremendous avalanche, which could rampage for a long time before it would spend
itself."[40] Thus, a regime of long-term deflation is likely to be interrupted by periodic spikes
of rapid inflation and consequent real economic disruptions. Moderate and stable inflation
would avoid such a seesawing of price movements.
Financial Market Inefficiency
with Deflation
The second effect noted by Tsaing is that when savers have substituted money holding
for lending on financial markets, the role of those markets in channeling savings into
investment is undermined. With nominal interest rates driven to zero, or near zero, from
the competition with a high return money asset, there would be no price mechanism in
whatever is left of those markets. With financial markets effectively euthanized, the
remaining goods and physical asset prices would move in perverse directions. For
example, an increased desire to save could not push interest rates further down (and
thereby stimulate investment) but would instead cause additional money hoarding, driving
consumer prices further down and making investment in consumer goods production
thereby less attractive. Moderate inflation, once its expectation is incorporated into
nominal interest rates, would give those interest rates room to go both up and down in
response to shifting investment opportunities, or savers' preferences, and thus allow
financial markets to function in a more normal fashion.

The Bank of England, central bank of theUnited Kingdom, monitors causes and attempts to control inflation.

Historically, a great deal of economic literature was concerned with the question of what causes
inflation and what effect it has. There were different schools of thought as to the causes of
inflation. Most can be divided into two broad areas: quality theories of inflation and quantity
theories of inflation. The quality theory of inflation rests on the expectation of a seller accepting
currency to be able to exchange that currency at a later time for goods that are desirable as a
buyer. The quantity theory of inflation rests on the quantity equation of money, that relates the
money supply, itsvelocity, and the nominal value of exchanges. Adam Smith and David
Hume proposed a quantity theory of inflation for money, and a quality theory of inflation for
production.[citation needed]

Currently, the quantity theory of money is widely accepted as an accurate model of inflation in the
long run. Consequently, there is now broad agreement among economists that in the long run,
the inflation rate is essentially dependent on the growth rate of money supply. However, in the
short and medium term inflation may be affected by supply and demand pressures in the
economy, and influenced by the relative elasticity of wages, prices and interest rates.[41] The
question of whether the short-term effects last long enough to be important is the central topic of
debate between monetarist and Keynesian economists. Inmonetarism prices and wages adjust
quickly enough to make other factors merely marginal behavior on a general trend-line. In
the Keynesianview, prices and wages adjust at different rates, and these differences have
enough effects on real output to be "long term" in the view of people in an economy.

[edit]Keynesian view
Keynesian economic theory proposes that changes in money supply do not directly affect prices,
and that visible inflation is the result of pressures in the economy expressing themselves in
prices. The supply of money is a major, but not the only, cause of inflation.

There are three major types of inflation, as part of what Robert J. Gordon calls the "triangle

Demand-pull inflation is caused by increases in aggregate demand due to increased private and
government spending, etc. Demand inflation is constructive to a faster rate of economic growth
since the excess demand and favourable market conditions will stimulate investment and

Cost-push inflation, also called "supply shock inflation," is caused by a drop in aggregate supply
(potential output). This may be due to natural disasters, or increased prices of inputs. For
example, a sudden decrease in the supply of oil, leading to increased oil prices, can cause cost-
push inflation. Producers for whom oil is a part of their costs could then pass this on to
consumers in the form of increased prices. Another example stems from unexpectedly high
Insured Losses, either legitimate (catastrophes) or fraudulent (which might be particularly
prevalent in times of recession).[citation needed]

Built-in inflation is induced by adaptive expectations, and is often linked to the "price/wage spiral".
It involves workers trying to keep their wages up with prices (above the rate of inflation), and firms
passing these higher labor costs on to their customers as higher prices, leading to a 'vicious
circle'. Built-in inflation reflects events in the past, and so might be seen as hangover inflation.

Demand-pull theory states that the rate of inflation accelerates whenever aggregate demand is
increased beyond the ability of the economy to produce (its potential output). Hence, any factor
that increases aggregate demand can cause inflation.[43] However, in the long run, aggregate
demand can be held above productive capacity only by increasing the quantity of money in
circulation faster than the real growth rate of the economy. Another (although much less
common) cause can be a rapid decline in the demand for money, as happened in Europe during
theBlack Death, or in the Japanese occupied territories just before the defeat of Japan in 1945.