INFLATION IN NEWS
INFLATION
§ Inflation is defined as a general and persistent rise in prices of a wide variety of goods and
services over a considerable
SL.NO INFLATION TYPE INFLATION RATE
period.
1 Creeping < 3%
CAUSES OF RISING PRICES
2 Trotting 3-10%
We can study the causes of
3 Galloping inflation 10-20%
inflation under three heads:
4 Hyperinflation 100%, 1000% etc
1. Demand Pull Inflation
2. Cost-Push Inflation
3. Structural Inflation
DEMAND-PULL INFLATION
In demand pull inflation, aggregate demand in the economy exceeds the aggregate supply of
goods and services. This puts an upward pressure upon over all prices and it culminates into
inflation. There could be many possible scenarios/reasons for demand pull inflation.
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The main reasons for demand-pull inflation are:
1. An increase in government spending leads to overall increase in consumption demand in
economy leading to inflation.
2. An increase in general income level in the economy leads to enhanced purchasing power
of people. This might induce demand pull inflation.
3. A rising population would create more demand for goods & services in the economy and
put inflationary pressure.
4. Change in taste and preferences towards a certain category of goods and services might
lead to a situation where demand outstrips supply and cause inflation to arise.
5. If money supply increases in the economy (say due to expansionary monetary policy
followed by RBI), it might create more demand for goods and services.
6. Deficit financing is the budgetary situation where expenditure is higher than the revenue.
The expenditure revenue gap is financed by either printing of currency or through
borrowing. In either case, the result is inflation.
7. When direct taxes like income tax or wealth tax are reduced, the disposable income of
people in general increases. This leads to increased aggregate demand and hence
inflation.
COST-PUSH INFLATION
Cost push inflation is caused by an increase in cost of production of goods and services. When
the cost of production goes up, the production and supply of the product and services go
down. This leads to inflation.
The main reasons for cost-push inflation are:
1. Increase in input prices like labour, raw material, etc. lead to a decreased supply of these
goods compared to demand. This puts pressure on prices.
2. Poor monsoon and rainfall leads to droughts and effects agricultural production. Shortage
of food and agricultural raw material leads to overall price rise in economy.
3. Once oil prices rise, transportation cost goes up and we observe an overall inflation in
economy. This is also referred to as imported inflation.
4. Phenomenon like hoarding and speculation reduce the availability of commodities in open
market leading to scarcity of supply in relation to demand. This certainly leads to inflation.
5. When indirect taxes like excise, customs or GST increase, the immediate impact falls upon
the producers in terms of higher cost of production. And ultimately it would lead to cost-
push inflation. Depending on the price elasticity of demand and supply, suppliers may pass
on the burden of the tax onto consumers.
STRUCTURAL INFLATION
§ Inflation in the developing countries are mainly due to the weak structure of their
economies. This creates a mis-match between demand and supply.
§ In developing countries, the structural facilities like lack of capital, technology, machines,
infrastructure, power etc. leads to supply bottlenecks and hence inflation.
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§ Lack of power, port, roads etc all lead to increased cost of production. Also, for example,
lack of good roads would lead to difficulties for making even the ready goods being taken
to the market (like perishable agricultural commodities). This would lead to inflation too.
EFFECTS OF INFLATION
Purchasing Power:
§ It reduces and hence standard Real Interest Rate = Nominal Interest Rate ─ Inflation
of living comes down. Say, Nominal Interest Rate = 10%, Inflation = 4% è
Distribution of income Real Interest Rate = 6%
§ Under mild inflation or continued slow rise in prices, profit keeps on increasing. As wages
and salaries remains more or less fixed, income of the industrial and business classes
increase relative to the income of working classes. Thus, there is a redistribution of income
in favour of the rich.
Asset Holders
§ Their value of wealth declines. So, they start investing in physical assets like gold etc.
Effect on Creditors:
§ Creditors loose out as they are paid cheaper rupees.
Effect on Debtors
§ Debtors benefit as they have to pay back in cheaper rupees.
Standard of Living
§ Inflation impacts our standard of living negatively.
STEPS TO CONTROL INFLATION
1. MONETARY POLICY
a. Quantitative Steps
b. Qualitative Steps
2. FISCAL POLICY
3. SUPPLY SIDE STEPS
MONETARY POLICY
§ Monetary policy refers to the policy to control money supply at the time of inflation in the
economy. These tools of controls are broadly two:
1. Quantitative Controls
2. Qualitative Controls
QUANTITATIVE CONTROLS
1. Bank Rate Policy: BR is the rate at which RBI rediscounts the approved bills held by
commercial banks. For controlling inflation and money supply, RBI can increase the Bank
Rate.
2. Repo Rate: It is the policy rate at which RBI lends money to the banks against securities
for infusion of liquidity. RBI can increase repo rate to control inflation.
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3. Reverse Repo Rate: It is the opposite of repo rate. It is the rate at which banks park their
surplus fund with RBI. RBI can increase this rate to control Inflation.
4. CRR (Cash Reserve Ratio) is the proportion of amount which each commercial bank has
to maintain in the form of hard cash. When RBI increases the CRR, the bank's lending
power decreases. Less lending means less money in the economy.
5. SLR (Statutory Liquidity Ratio): All commercial banks must maintain liquid assets in the
form of cash, gold and approved securities equal to a certain percent of their total demand
and time deposit liabilities. In case of inflation, RBI can increase SLR which would reduce
their capacity to grant loans - thus it is anti-inflationary
6. Open Market Operation (OMO):
§ OMOs are the market operations conducted by the Reserve Bank of India through
which RBI either purchases or sells government bonds in the open market.
§ When the RBI feels there is excess liquidity in the market, it resorts to sale of securities
thereby sucking out the rupee liquidity.
§ Similarly, when the liquidity conditions are tight, the RBI will buy securities from the
market, thereby releasing liquidity into the market.
QUALITATIVE CONTROLS
The qualitative controls measures are also used by RBI to control inflation. Qualitative
measure is used by the RBI for selective purposes. For example, RBI uses Moral Suasion, i.e.
psychological means and informal means of selective credit control to control liquidity in
economy. Through this method central bank mainly uses its moral influence to make the
commercial banks follow its policies.
FISCAL POLICY
§ Fiscal Policy is the policy related to revenue and expenditure of the government for
achieving a set of objectives. To combat inflation, fiscal measures would involve increase
in direct taxation or decrease in indirect taxes, decrease in government spending,
reduction of deficit financing etc.
SUPPLY SIDE STEPS
§ Export Controls & Increase of Import: When some items like onions, pulses are in short
supply, government controls their export and increase their imports to control inflation.
§ Check upon hoarding and speculation to control prices.
§ Government can also put a price ceiling on some essential commodities like life saving
medicines, food items etc in to control inflationary pressure.
§ Improve agricultural markets to smoothen out availability of food items across India.
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MONETARY POLICY & INFLATION TARGETTING IN INDIA
§ In India, subsequent to recommendations of the Dr. Urjit Patel Committee Report, the
target for inflation – as measured by the consumer price index-combined (CPI-C) – in
the near to medium-term has been set as follows, i.e.,
a. Below 6 per cent by January 2016, and
b. 4 per cent (+/-) 2 per cent for the financial year 2016-17 and all subsequent years.
PHILLIPS CURVE (Growth versus Inflation)
§ It shows that if a country wants to control inflation, there is a fear of declining output and
employment. In other words, there is an inverse relationship between rate of growth of
unemployment and rate of growth of wages, i.e. higher the rate of inflation, lower the
unemployment and vice-versa.
§ Thus, high levels of employment can be achieved only at high levels of inflation. This
suggests policymakers have a choice between prioritising inflation or unemployment.
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