INFLATION

SARAVANAN S

What isInflation ? Inflation : Inflation is defined as a rise in the general price

level over a period of time.

In other words, prices of many goods and

services such as housing apparel, food,

transportation, and fuel become dearer during

inflation.

Deflation : Deflation is defined as fall in the general price

level over a period of time.

What happens during Inflation : Value of Money goes down↓↓ and Prices rise High↑↑

Both Inflation and Deflation create Problems…

Types of Inflation

Creeping Inflation

Walking or trotting Inflation

Running Inflation

Galloping Inflation

Hyper Inflation

Theories and Causes of Inflation

The main cause of inflation is the increase in the demand of goods

and services and at the same time decrease in the supply of goods

and services.

There are two theories related to the causes of inflation:

Demand-pull (when there is excess demand), and

Cost-push (when costs rise)

Theories and Causes of Inflation

Demand Pull Inflation –

This occurs when there is excess

aggregate demand in the economy

(overall) or in a specific market or

industry.

Businesses respond to high demand

by

raising prices to increase their profit

margin

Theories and Causes of Inflation

• Cost – push Inflation :

This occurs when costs of production or

operation are increasing.

• Cost Push inflation is mainly caused due to

the following factors:

· increase in wages.

· increase in cost of

raw materials

· increased cost of

imported components

(import-push inflation)

Growth vs. Inflation: India, 1951-2011

Period

Average annual growth rate of GDP at

constant prices (%)

Average annual rate of

WPI inflation (%)

2005-06 to 2010-11 8.47 6.55

2000-01 to 2005-06 6.93 4.68

1995-96 to 2000-01 5.92 5.07

1990-95 to 1995-96 5.38 10.18

1980-81 to 1990-91 5.64 8.51

1970-71 to 1980-81 3.16 10.28

1960-61 to 1970-71 3.75 6.24

1950-51 to 1960-61 3.94 1.75

The Indian evidence above shows the lack of any simple

unidirectional relationship between inflation and growth.

WPI - Wholesale Price Index

- measured weekly in India

The relative price of food is computed

as the ratio of the WPI component for

primary food commodities to an index

of non-food manufacturing prices

computed from WPI data.

Rate of Inflation

Why is Inflation a Problem in India?

Inflation makes some people worse off, but it makes others better off

Ex: 1. Increase in Gasoline prices affect the Truck drivers more but barely affects people

who go to there work by walk and economy vehicles

2. College tuition fees has risen almost twice as fast as average prices over the past

10 years, which hurts you a lot,

but may have little impact on a married couple with no children.

3. Poultry diseases causes a rise in the prices of Non-veg food items and affect people

who eats more of Non- veg

food items but it barely affects people eating Veg food.

4. People in Cities get affected more than people in small towns and villages

Price Effects :

Income Effects :

Prices for goods and services mean income for some people. So, as some prices

increase faster

than other, some people’s income increase faster than others.

Ex: 1.Due to increase in number of automobiles working on Gasoline increased,

due to this most of the Oil companies

record very high amounts of improvements in profits every year

2. Due to ever increasing in pollution, the number of people suffering from

different diseases also increased which gave

chance to many pharmaceutical companies to improve profits every year

3. All the retail stores working on % profit’s increase there income when ever

there is increase in prices of goods

Wealth Effects :

1. Inflation redistributes income between Borrowers and Lenders

2. Inflation benefits the borrowers and hurts the lenders

Reason: As the value of money decreases at higher rate

Inflation redistributes the social conditions of people

Causes of Inflation

Factors on Demand side :

1. Increase in Money Supply

2. Increase in Disposable Income

3. Deficit Financing

4. Foreign exchange reserves

Factors on Supply Side :

1. Rise in administered prices

2. Erratic agricultural growth

3. Agricultural price policy

4. Inadequate industrial growth

Printing Of Money

is never a

Solution for Inflation

Factors on Demand side

1. Increase in Money Supply

If the currency in circulation increased, there would be a proportional increase in the price of goods

2. Increase in Disposable Income

Disposable income is total personal income minus personal current taxes. disposable income is the amount of "play money“ left to spend or save. If this is increased people spend money on unnecessary things and there demand increases and thus inflation

3. Deficit Financing

government spends more money than it receives as revenue, the difference being made up by borrowing or minting new funds, minting new funds decrease the value of money and thus inflation

4. Foreign Exchange Reserves

Foreign exchange reserves include foreign currency deposits and bonds and also adds gold reserves, which increase the circulation of money and thus inflation

Factors on Supply Side 1. Rise in administered prices

Prices decided by an individual producer or seller not purely by market forces, this is common when there is only one supplier and he has chance to increase the cost with out any conditions

2. Erratic agricultural growth

India is country where in 60% of people still relay on farming and the weather is so uneven and prices depend on the agricultural productivity

3. Agricultural price policy

Due to fluctuating prices during mid 60’s during the Pakistan war APP was introduced to ensure stability in prices, so when the supply decreases they have to manage the prices in order to stabilize the cost and inflation occurs

4. Inadequate industrial growth

Most of the markets in India run foreign imported products due to lack of technology and other issues, so the pieces also keep fluctuating on the other countries markets and market value and too much imports can lead to fall of value of money

Increase in Printed Money Increase in Disposable Income

Due to Increase in disposablemoney people spend moneylavishly independent of therenecessity and thus there is increase in Inflation

Mainly seen in IT Sector in India due to

its speedy growth

Deficit Financing

This happens every yearin India and India has a debt of 172 Billion Dollar up-to

now and still unable to repay it to World bank

Foreign Exchange Reserves

Forex reserves increase every week due to good participation of foreign companies and latest reports from RBI says 293 Billion Dollar investment from Foreign companies

Factors on Demand side

Factors on Supply Side Rise in administered prices

In case of India the administer can be government or individual if it is

government then it is a fixed price if it is on the individual then there is lot more variations based on ones

decision costs are decided

Erratic agricultural growth

Vegetable Max

Cost/kg

Min

Cost/kg

Tomato 60 5

Potato 30 14

Onion 70 20

Cauliflower 45 20

Brinjal 45 20

Factors on Supply Side

Agricultural price policy

Though APP was successful for in some regions but due to poor Infrastructure the food grains and vegetables stored always get

spoiled and due this the demand supply would decrease

Inadequate industrial growth

GDP growth

which clearly

depicts Industrial

Growth

They add inefficiencies in the market and make it difficult for companies to budget or plan for long term

Uncertainty about the future purchasing power of money discourages investments and savings

Higher income tax rate

There can be negative impacts to trade from an increased instability in currency exchange prices caused by unpredictable inflation

If the inflation rate in the economy of a country is higher than rates in other economy’s there will be huge increase in imports and decrease in exports (in terms of vaule) and hence huge fall in GDP

Value of money decreases

Measures to control Inflation1. Effective policies to control inflation need to focus on the underlying causes of

inflation in the economy

Ex: 1. If the main cause is excess demand for goods and services, then

government policy should look to reduce the level of aggregate demand

2. If cost-push inflation is the root cause, production costs need to be controlled for the problem to be reduced

Step to be takenInvestment in infrastructure and human capital to ensure that desired growth

does not exceed the productive capacity of the economy.

Step to be takenIn the short-run the RBI should raise interest rates sharply to protect

its anti-inflationary credibility.

2. If Inflation is for short period of time and If not Food Inflation

3. To eradicate Erratic agricultural growth problem

Step to be takenInvestment and promotion of organizational innovations in agriculture to ensure that food supply does not become a bottleneck to growth and price to price (cost

effectively)

4. Demonetization Of Currency

Step to be takenPrimarily to curb unaccounted money. The higher denomination banknotes in

Rs.5000 and Rs.10000 were to reintroduced and these banknotes (Rs.5000 and Rs.10000) were to be demonetized

5. A strong Fiscal Policy Reduction in unnecessary expenditure by the government

Step to be takenExpenditures on public functions and rally's and public meeting, usage highstandards Infrastructure by public officials need to be decreased to certain

fixed level

6. Check on the amount the government sector borrows each year

7. Moving towards greater independence for the central bank and transparency in

monetary policy to stabilise inflationary expectations.

8. Increase in Savings

What happens

with fiscal Policy

These fiscal policies increase the rate of leakages from the circular flow and reduce injections into the circular flow of income and will reduce demand pull inflation at the cost of slower growth of economy

Policy recommended for short-run

Fiscal consolidation to ensure that fiscal policy does

not work at cross-purposes with monetary policy.

A loose fiscal policy, by increasing the debt burden both directly and through its effect on interest rates, would prove to be unsustainable in the long run

As the debt burden rises, the pressure to print money to finance the fiscal deficit would rise, thereby making it impossible to pursue an anti-inflationary monetary policy.

Inflation is as violent as a mugger, as frightening as an armed robber and as deadly as

a hit man.

Ronald Reagan