INFLATION AND MEASURES TO CONTROL INFLATION

INTRODUCTION

Inflation is one of the striking features of the economic situation of today.

Although prices were by no stable in the fifties and sixties in the last 5 years the
inflationary process has shown strong acceleration. Government action to counter
this process has been rather unsuccessful up to now. Moreover, in the discussion
on how to combat inflation it has turned out that opinions on the causes and
consequences of inflation differ widely. Some hold the opinion that the inflation is
a monetary phenomenon that has to be fought by means of monetary instruments
whereas by others believe that inflation is due to differences in growth rates of
average labor productivity and capacity utilization rates as between different
sectors and to such institutional factors as rigidity of the wage structure, a strong
increase in social security premiums and taxes and discord with respect to income
distribution and the economic and social order in general. Inflation's effects on an
economy are manifold and can be simultaneously positive and negative. Negative
effects of inflation include a decrease in the real value of money and other
monetary items over time; uncertainty about future inflation may discourage
investment and saving, or may lead to reductions in investment of productive
capital and increase savings in non-producing assets. e.g. selling stocks and buying
gold. This can reduce overall economic productivity rates, as the capital required to
retool companies becomes more elusive or expensive. High inflation may lead to
shortages of goods if consumers begin hording out of concern that prices will
increase in the future. Positive effects include a mitigation of economic recession
and debt relief by reducing the real level of debt.

High rates of inflation and hyperinflation can be caused by an

excessive growth of the money supply. 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. Today,
most mainstream economist favor a low steady rate of inflation. Low (as opposed
to zero or negative) inflation may reduce the severity of economic recession by
enabling the labor market to adjust more quickly in a downturn, and reduce the risk
that a liquidity trap prevents monetary policy from stabilizing the economy. The
task of keeping the rate of inflation low and stable is usually given to monetary
authorities. Generally, these monetary authorities are the central bank that controls
the size of the money supply through the setting of interest rates, through open
market operation, and through the setting of banking reserve requirement. In India
inflation is major cause of concern. It is the biggest enemy of the country.
Majority of people in India lives below poverty line, they don’t get proper food to
eat, clothes to wear, and proper shelter to live. On top of that inflation is taking
lives of many poorer people. Today the food inflation has raised exorbitantly due
flood, draught and no proper well sophisticated equipments for agricultural
activities. We totally rely on monsoon for bumper crops rather than looking for
other alternatives.

MEANING OF INFLATION

Inflation is generally defined as a process of persistent and appreciable rise in the

general level of prices. In another word it measures annual rate of general prices
level in the economy. Four important points to note about the definition is that-

 Inflation is a sustained increase in the average price level and not a state of
high prices. It is a state of disequilibrium between the aggregate demand and
aggregate supply at the existing prices, necessitating a rise in the general
price level.
 Inflation refers to a situation of appreciable or considerable rise in prices.
 Rise in prices should not only be appreciable but prolonged in order to be
termed as inflationary price rise.
 It is measured as the rate of increase in the price level as indicated by the
price index.

When the price rise, the value of money falls. In other words, there exists an
inverse relationship between the price level and the internal purchasing power of
money. During inflation money buys less in real terms. To protect from the effects
of inflation people can invest their money in the financial assets that give a rate of
return at least equal to the rate of inflation.

Definition of inflation

A few definitions from different economists would enable us to understand the

meaning of inflation better. Following are the definitions of inflation;

1 professor Ackley; “ a persistent and appreciable rise in the general level or

average prices.”
2Pigou; “when money income is expanding more than in proportion to income
earning activity”. An increase in general price level takes place when people when
people have more money income to spend against less goods and services.”

3 Crowther;”inflation is a state in which the value of money is falling i.e. prices

rising”

Characteristics of inflation

1Its is a situation of disequilibrium where there is too much money and too few
goods and services.

2 The quantity or supply of money is far in excess of supply of goods and services.

3A temporary rise in price cannot be termed as inflation.

4The important factor responsible for inflation are either excess demand or
increase in cost or both.

5Inflation is measured in terms of ratio of increase in level of general price. We

therefore usually measure inflation in percentage increase in price as 4 percent, 8
percent.

Inflation in India

India has been the cynosure for the past few years in the global economic arena
owing to its changing inflation patterns.

Inflation in 2007

Inflation in 2007 has been reflecting at 4.05 percent decline during the month of
august. Rates of inflation in prices in India decreased due to lowering of prices of
vegetables, poultry chicken, fruits, lentils, and a few manufactured items.

Inflation in July 4.45 percent, only a few manufactured goods had

experienced reduction in prices in the process. The rate of inflation for wholesale
goods was 6.69 percent in January and it had come down to 4.28 percent in June
and reduced by 4.03 percent towards the end of the month, thus adding to the
lowering of India inflation in 2007. Interestingly the annual inflation up to 21st
April was 5.77 percent which went up to 6.07 percent thereafter. However because
of better monsoon in July it had resulted better crops and other farm items, leading
to reduction in prices.

Inflation in 2008

From the beginning of FY2008 the Indian economy faced a rise in the prices of
vegetables, pulses and other basic food stuffs. All this was accompanied with sharp
rise in the prices when the annual policy statement for 2008-09 was unveiled on
April 29. Inflation increased steadily during the year, reaching 8.75% by the end of
May and in June when this figure jumped to 11% then there was an alarming
increase in the prices. There were many reasons for it but one of the main driving
forces was reduction in government fuel subsidies, which lifted gasoline prices by
an average 10%. Indeed, by July 2008, the key Indian Inflation Rate i.e. the
Wholesale Price Index touched the mark of 12.6%, highest rate in past 16 years of
the Indian history. This was almost three times the RBI’s target of 4.1% and almost
doubled as compared to last year. This continuous rise slipped back to 12.4% by
mid-August.

Since the beginning of 2008 combination of various internal and external factors
led to steep domestic inflation and the resultant steps taken to control it in were
slowing the pace of expansion. These factors included the marked rise in the
international prices of oil, food, and metals, moderating the rate of capital inflows,
worsening current and fiscal account deficits, increasing cost of funds, minor
depreciation of the Indian rupee against the dollar, and slow growth in industrial
economies. The Indian economy was at a critical juncture where policies to contain
inflation and ensure macroeconomic stabilization have taken center stage.

In the first quarter of FY2008 (i.e. April–June), growth rate of GDP slowed down
to 7.9% from 9.2% in the corresponding prior-year quarter, for the slowest
expansion in three and a half years. The most remarkable decline was in industry
where growth rate fell to 6.9% this was mainly because of cutting in the
manufacturing growth rate to 5.6%. The slowdown was widened when agriculture
and services sector showed a negligible growth of 1.4% and 0.9% points, below
their performances of the year-earlier quarter. Over the medium term, the main
objective of the government was to bring down inflation to 3%. Consumption
expenditure showed a steady growth in the first quarter of FY2008. Expansion in
fixed investment fell to 9.0% from 13.3% due to increasing interest rates and a
weakening global and domestic outlook appear to be causing companies to cut
down their investment. Data available for June confirms a general slowdown in the
industrial production, which is most noticeable in basic, intermediate, and
production of capital goods. This indicates that investment in the recent years has
accounted for much of GDP growth; rising to about 34% of GDP in FY2007—is
slackening. Consumer durable goods production increased due to strong rural
demand whereas nondurable goods production contracted. A survey of
manufacturing companies was conducted by the Reserve Bank of India in June
2008 which indicated a moderation in business optimism.

Inflation in 2009

The headline inflation, as measured by year-on-year variations in the wholesale

price index (WPI), decelerated from a peak of 12.91 per cent on August 2, 2008 to
0.84 per cent at end-March 2009 and turned negative in June 2009. The increased
volatility in WPI inflation needs to be seen in the context of the behavior of the
global commodity prices. Reflecting the sharp increase in oil and metal prices,
WPI inflation had risen to double digits in June 2008 and remained elevated till
October 2008 tracking the firm global commodity prices. As the global commodity
prices moderated from their peak levels, domestic prices also adjusted, setting off a
converse movement in WPI inflation. That volatility in WPI flowed largely from
international commodity prices is evident from the trend in WPI inflation
excluding mineral oils and metals (weight in WPI: 15.3 per cent), which is less
volatile than the overall WPI inflation.

WPI inflation for the week ended July 11, 2009 was (-) 1.17 per cent. The negative
WPI inflation is expected to persist for a few more months till the base effect wears
off. The evolution of WPI inflation so far has been along the lines anticipated in
the Annual Policy Statement of April 2009. The currently observed negative WPI
inflation largely reflects the statistical effect of the high base of last year and
should not be interpreted as structural deflation arising from demand contraction.
The divergence between WPI and CPI inflation rates has become more
pronounced in the recent period with the WPI inflation turning negative, while
the CPI inflation is ruling in the range of 8.6-11.5 per cent. This is in contrast to
the historical trend when CPI inflation has tracked WPI inflation, albeit with a lag,
as wholesale price changes are followed by retail price changes. In recent months,
CPI inflation has remained stubborn at elevated levels due to increased prices of
food items, which have a higher weight in the CPI basket than in the WPI. As
would be expected, CPI inflation tracks the essential commodities component of
WPI inflation quite closely. The divergence in various price indices evidently
increases the complexity of inflation assessment. For its overall assessment of
inflation outlook for policy purposes, therefore, the Reserve Bank, as always,
monitors the full array of price indicator

Inflation chart from 2006-2009

Year Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
2009 10.45 9.63 8.03 8.70 8.63 9.29 11.89 11.72 11.64 11.49 -10.45 -9.70
2008 5.51 5.47 7.87 7.81 7.75 7.69 8.33 9.02 9.77 10.45 10.45 9.70
2007 6.72 7.56 6.72 6.67 6.61 5.69 6.45 7.26 6.40 5.51 5.51 5.51
2006 4.39 5.31 5.31 5.26 6.14 7.89 6.90 5.98 6.84 7.63 6.72 6.72

15

10

0 Series 3
2006 2007 2008 2009
-5

-10

-15

Inflation rates

Inflationary trends in India.

The Indian economy has shown a remarkable growth after the adoption of
liberalization policy. The opening up of the Indian economy in the early 1990s led
to increase in industrial output and simultaneously raised the Inflation Rate in
India.
There was an immense pressure on the inflation rate due to the stupendous growth
rate of employment and industrial output. The main concern of the Reserve Bank
of India (the central bank) and the Ministry of Finance, Government of India was
the prevalent and intermittent rise of the inflation rate. Increasing inflation rate
could be detrimental to the projected growth of Indian economy. Thus, the Reserve
Bank of India was putting checks and measures in various policies so as to put a
stop to the rising inflation. The Indian business community and the general public
were assured by the central bank that the inflationary rise was harmless but still
certain apprehensions existed among them.
The pricing disparity of agricultural products between the producer and end-
consumer was contributing to the increasing Inflation Rate. Apart from this the
steep rise of prices of food products, manufacturing products, and necessities had
also catapulted the Inflation Rate. As a result of all this, the Wholesale Prices
Index (WPI) of India reached 6.1% and the Cash Reserve Ratio touched 5.5% on
6th January, 2007.

The Reserve Bank of India gave top priority to price stability in monetary policy so
as to arrest the panic and discomfort amongst the Indian business circles. It also
aims to sustain the stupendous rate of economic growth of India. The Reserve
Bank of India raised the Cash Reserve Ratio and used it as a tool to arrest the
increasing Inflation Rate.
Rationalizing the pricing disparity between the producer and the consumer is the
only solution to this problem. Only this will ensure inflation stabilization and thus
sustainable economic growth of India.

Types of inflation
1 creeping inflation: this also known as moderate inflation. This type of inflation
occurs when the general price level rises persistently over a period of time at mild
rate. When the rate of inflation is less than 10 percent annually or in single digit it
is said to be moderate inflation.

2 galloping inflation: if the mild inflation or if it is uncontrollable it is the character

of galloping inflation. Inflation in double digit or triple digit say 20, 100 percent it
is called galloping inflation. Many Latin American countries such as brazil,
Argentina had inflation of 20 to 100 percent during 1970s.

3 Hyperinflation: It is a stage of very high rate of inflation. While economies seem

to survive under galloping inflation, a third and deadly strain takes hold when the
cancer of hyperinflation strikes. Nothing good can be said about a market economy
in which prices are rising a million or even a trillion percent year. Hyperinflation
occurs when the prices go out of control and the monetary authorities are unable to
impose any check on it. Germany witnessed hyperinflation in 1920’s.

4 Deflation: It occurs when the general level of prices is falling. It is opposite of

inflation .A.C. PIGOU defines deflation as a” state of falling prices which occurs
at the time when the output of goods and services increases more rapidly than the
volume of money income in the economy.” Deflation results in

 A fall in the general level of prices

 Increase in the value of money

 A decline in effective demand and

 An increase in unemployment

5 Reflation: it refers to a state of affairs under which controlled inflationary

conditions are created to overcome deflationary situation in the economy. It is an
inflation deliberately undertaken to relieve depression. Deflation if continues for a
long period has its negative effect that is, to revive the economy from recession or
depression reflation is resorted to. Reflation is expected to result (1) a gradual
increase in price level.(2) decline in unemployment and(3) increase in output.
Reflation is brought about through a gradual increase in money supply.

6 Disinflations: it is a situation where the government or monetary authorities

adopt measures to arrest inflation through corrective measures. Disinflation occurs
when inflation is brought to normal level. It is mild form of deflation but without
its serious negative effects. Monetary and fiscal measures are adopted to bring in
the disinflationary condition.

Causes of inflation
Inflation being a state of continuous increase in price level is mainly caused by
excess demand and/or increase in supply price. Broadly speaking the factor
responsible for inflation can be discussed under ‘demand pull and cost push
inflation’

DEMAND_PULL INFLATION:

Demand-pull inflation is also called excess demand inflation. Demand-pull

inflation implies that demand for goods and services are pulled above the capacity
of the economy to produce goods and services in a given period. Factors
responsible for demand-pull inflation are as follows:

Factors on demand side affecting general level

1Increase in money supply: when the monetary authorities increase the money
supply in excess of the supply of goods and services it results in additional demand
and consequent increase in price level. Money has an impact on output and price.
The process of money creation is a process of credit creation. Money comes into
existence because credit is given either to the government or to the private sector
or to foreign sector. Since credit facilitates the production process it has favourable
impact on output. But at the same time the increased money supply raises the
demand with an upward pressure on prices.

2 Increase in public expenditure. Public expenditure has steadily risen in India. In

democratic political set up, with the creation of new institution some increase in
public expenditure is evitable. Over the planning period, the net national income
has increased at the rate of 4.6 percent per annum. With this rise in the national
income and also rapid growth of population, an increase in public expenditure was
unavoidable, but no had expected that the government would incur such a heavy
expenditure. No doubt, defense and maintenance of law and order are essential
services for the stability of the society. At the same time, it must not be forgotten
that due to their unproductive nature, expenditure on these activities results in
inflationary price rise. The government expenditure on non- developmental
services, by putting purchasing power into the hands of employees, creates demand
for goods and services, but it does nothing whereby it could increase supply. Under
such circumstances the price tends to rise.

3 Deficit financing. When the government is not able to raise adequate revenue for
its expenditure, it can meet its deficit by borrowing funds from banking system. An
increase in money supply also takes place when the government resorts to deficit
financing to incur the public expenditure. Deficit financing undertaken for
unproductive investment or expenditure becomes purely inflationary. Even when it
is used on productive activities, prices would still increase during the gestation
period.

4Credit creation: Commercial banks increase the quantity of money in circulation

when they advance loans through credit creation. Credit creation is similar to that
of deficit financing.

5Exports: Exports reduces the goods available in domestic market. Export earning
enhances the purchasing power of the exporters and others linked with export. An
increase in exports would aggravate the situation by reducing the supply of goods
and at the same time pushing up the demand.

5Repayment of public debt: public debt is common features of modern

government. When such debts are repaid, people will have more income at their
disposal. Additional disposable income tends to raise the demand for goods and
services.
Factors on supply side affecting general level

Factors on the supply side generally operate through their effect on the cost of
production. But in a non-competitive market, producers often try to maximize
their profits by creating artificial scarcities. In India, where production has
not increased at desired rate, hoarding of essential commodities and the
government’s price support policy have also contributed to the price rise.

1Erreatic agriculture growth. The Indian agriculture sector largely depends on

monsoon and thus crop failure due to draughts has been regular feature of
agriculture in this country. In the years of scarcity of food grains, not only the
prices of food articles increased, but the general level also rose. Whenever the
agricultural output declined in this country in the market arrivals of agriculture
products also declined. In many years the decline in the market arrivals was much
more than the decline in the agricultural output and caused immense rise in
agricultural products. Moreover, under the pressure of rising prices of food grains,
industrial workers who spend a major part of their incomes on food have forced
their employer to raise their wage rates. Consequently the prices of industrial
products shoot up.

2 hoarding of essential articles. Failure of crops always encouraged big farmers

and the wholesale dealers in agriculture products to indulge in hoarding with the
expectation that the prices of these commodities would rise. This behavior of
producers and middlemen is in clear conflict with the interest of the society.
Hoarding when production goes down in the country aggravates scarcity
conditions and pushes up the price level. Although hoarding has been a common
phenomenon in India throughout the period of economic planning, it was one of
the major causes of upward movement of prices in 1991. Due to hoarding of
essential products it creates artificial scarcity which has an adverse effect on the
prices, which becomes unaffordable for poor section of the society. They look for
substitution and could feed him with nourishing food.

3Agricultural price policy of the government. In India, until recently, farming was
done purely for subsistence. Market conditions rarely influenced the behavior of
farmers. Most of the agricultural produce which came to the market in the cities
was the result of various economic compulsion and economists characterized it as
distress sale. Since the abolition of the zamindari conditions has changed as new
classes of large and big farmers have emerged on the rural scene this class of
farmers has a real marketable surplus and its behavior is significantly influenced
by price movements. In order to provide incentives, particularly to farmers with
marketable surplus, the government has been pursuing a policy of price support for
about three decades. By announcing the prices at which it would be buying
agricultural products, it not only ensures certain minimum prices to the farmers but
also completely eliminates the element of risk involved in farming activities. This
policy has largely benefited large farmers but also it has been a major cause of
inflation. Large and big farmers used to hoard the products for raising prices and
then pressurizing the government to raise the support prices.

4 inadequate rises in industrial production. Industrial production increased at the

rate of only 4.2 percent per annum over the period of 1965 to 1976 and at the rate
of only 6.1 percent per annum over the period of 1974 to 1979. The year 1979-80
recorded a negative growth of -1.6 percent. Due to deceleration of industrial goods
there was the shortage of goods, which contributed to inflation.

5 upward revision in administered prices. There are number of important

commodities for which price level has administered by the government. Many of
these administered prices are for commodities produced in public sector. The
government keeps on raising administered prices from time to time in order to
cover up losses in the public sector units which often arise due to inefficiency and
unimaginative planning. Obviously the right policy would be reducing costs by
improving the efficiency in the public sector units. This, however, requires a lot of
efforts and therefore, government prefer the easier alternatives, that is, raising
administered prices.

Cost –push inflation

INFLATION may take place independent of demand forces. Given the demand
price level may go up due to an increase in cost or supply price. The main factors
affecting cost are wages, material cost, profit (mark –up) and others which have
direct or indirect influence on the cost. Following are the factors:
1Wages: when prices increase due to increase in wages it is called wage –push
inflation. Wages are influenced by many factors besides the demand and supply
forces. Trade union plays an important role in deciding the wage rate. Strong and
powerful trade union succeed in securing higher wages. Higher wages granted in
the organized sector influence the wage rate in the unorganized sectors too,
resulting in an increase in cost everywhere. Every increase in the wage need be the
cost-push inflation. The increase in wage be may because of increased productivity
or of higher profit earned by the industries do not affect the cost. The burden of
high wage rate is shifted forward on to the consumer in the form of higher prices
unless the demand is inelastic.

2Material cost: Prices of material used in producing goods constitute a significant

part of the cost. Prices of the material may increase either due to an increase in
demand for these materials or due to national and international development. For
example increase in crude oil .when the prices of crude oil increase the petroleum
products shoot up and the effect is felt throughout the economy. When the prices of
basic inputs increase it is pass on to the consumers and they get affected. An
increase in the material especially the basic inputs alters the structure of all goods
and services. Higher cost of production leads to upward revision of final prices. In
the last two decades the prices of all materials have gone up either due to market
forces or administrative decisions. Increase in material cost thus has become one of
the important factors responsible for continuous upward movement of price level.

3Increase in profit margin: Firms operating under monopoly power (petroleum

firms of public sector) may have administered prices with higher profit margin.
Such administered prices though imposed by few firms have their impact on other
firms too. While firms enjoying some monopoly power will find it easy to hike the
prices, others will compelled to raise their prices due to higher material cost as a
result of initial spurt in administered prices. The desire to have higher profit
margins by all those who have the power to do so becomes the cause of
inflationary trend.

OTHERS FACTORS:
Cost of production may increase when input prices go up due to scarcity – natural
or artificial. Natural calamities like draught or flood adversely affect the supplies
of raw material thus making them dearer. Firms operating with excess capacity
either because of monopolistic competitive market or any other reasons, produce at
a higher cost.

INFLATIONARY GAP
The concept of inflationary gap was introduced by Keynes in 1940. Inflation,
according to Keynes is a post –full employment phenomenon. It is a
situation of excess demand for goods and services over the available supply
at constant or pre inflationary prices. . Inflationary gap is represented by
the difference between the nominal income and the real income when
the economy operates beyond the level of full employment.

1 National income at current prices Rs 1000 crores

2 Taxes Rs 200crores
3 Disposable income Rs 800crores
4 National income at pre- inflation prices Rs 900crores
5 Government expenditure(requirement) Rs 200crores
6 Output available for public consumption at Rs 700crores
pre-inflation period (4-5)
Inflationary gap Rs 100crores

Measuring inflation
Changes and movement in prices influence buying and selling decisions, and thus
the economic scenario. Hence the government, businesses, producers and
consumers keep a constant check on prices. However, given the large number of
items that are sold and purchased every day, it is difficult to keep track of all of
them.

That is where price indices come in. They give a sense of the overall direction and
trend in prices. These indices are available for different sectors and for different
groups of people.

There are indices based on prices in different markets or at different points of sales.
Of the many indices, two are of critical importance. The first is the Wholesale
Price Index (WPI), which is based on the price prevailing in the wholesale markets
or the price at which bulk transactions are made. The other is the Consumer Price
Index (CPI), which is based on the final prices of goods at the retail level. Both
these indices are the weighted averages of prices of a specified set of goods and
services. The WPI is compiled and published by Office of the Economic Advisor
on a weekly basis while the CPI is compiled and published by the Lab our Bureau
on a monthly basis in India. The CPI is published for rural, agricultural and
industrial workers.

Uses of indices

These indices are used for various purposes including forecasting of for businesses
used by organizations and institutions for their analysis and by RBI for framing
monetary policy and fiscal policy etc The WPI is used to measure inflation due to
non availability of appropriate CPI.

Measuring of inflation is done by two ways;

1 wholesale price index and,

2Consumer Price Index (CPI)

1. Wholesale price index.

Whole sale price index is an economic indicator available to the policy

makers. This was invented in 1902 on replaced by product price index. Generally it
is referred as WPI.
 This is an economic indicator which is used to tell and measure the changes in
the changes in the average price level of goods and services traded at wholesale
market or price at big sale. WPI is an indicator to follow the growth of economy in
general, and as material in analyzing the market and monitoring growth. WPI is a
widely used price indicator in many countries. It list hundreds of item and help a
policymaker to make economic related decision. Hundred of commodities data on
price level is tracked. This is very comprehensive data. It is one of the best indexes
for capturing price movements in a comprehensive way. Wholesale price index is
an index that depicts the moving prices of commodities in all trade and transaction.
There are a lot of advantage of using WPI, first of all it is very comprehensive, and
gives a lot of information of what’s happening to the general prices of the
commodities, secondly that it is widely available everywhere and thirdly it is
updated on weekly bases with the shortest possible time lag of two weeks. These
are the attributes that make it popular all through the industries, organization,
businesses and government sector.WPI is also taken as the indicator of the rate of
inflation in the economy. The purpose of the WPI is to monitor price movements
that reflect supply and demand in industry, manufacturing and construction. This
helps in analyzing both macroeconomic and microeconomic conditions. Wholesale
price index is calculated by collecting data from central cities, provinces, state of
capital of provinces or states. Wholesale price index is divided into different
groups, representing different industries and businesses. Mostly WPI is divided
into a few groups, for example Agriculture, Manufacturing, Mining, and quarrying,
import and export where each sector consists of sub commodity groups. Each
commodity group in turn contains many commodities. Through this way all
commodities are covered from all sectors and the average prices of all
commodities are calculated at central. Out of 435 items, primary articles (consist of
food and non food items) contributes 98 items, fuel power, light and lubricant 19
items and manufactured contributes 318 items.

Components of wholesale price index

Following are the weight ages given in WPI:

Here food features twice in the index – once under primary articles, and then under
manufactured products, and has got a sizeable influence on the index indeed.

Here are the different components along with their weight age in Wholesale Price
Index (WPI).

Primary Articles
Food Articles 15.4025
Non Food Articles 6.1381
Minerals 0.4847
Sub Total 22.0253
Fuel, Power, Light & Lubricants
Coal Mining 1.7529
Mineral Oils 6.9896
Electricity 5.4837
Sub Total 14.2262
Manufactured Products
Food Products 11.5378
Beverages, Tobacco and Tobacco Products 1.3391
Textiles 9.7999
Wood and Wood Products 0.1731
Paper and Paper Products 2.0440
Leather and Leather Products 1.0193
Rubber and Plastic Products 2.3882
Chemicals and Chemical Products 11.9312
Non-Metallic Mineral Products 2.5159
Machinery and Machine Tools 8.3633
Transport Equipment and Parts 4.2948
Basic Metals and Alloys 8.3419
Sub Total 63.7485
Grand Total 100.00
Calculation of wholesale price index

WPI is calculated on a base year and WPI for the base year is assumed to be 100.
To show the calculation, let’s assume the base year to be 1970. The data of
wholesale prices of all the 435 commodities in the base year and the time for which
WPI is to be calculated is gathered.

Let's calculate WPI for the year 1980 for a particular commodity, say wheat.
Assume that the price of a kilogram of wheat in 1970 = Rs 5.75 and in 1980 = Rs
6.10

The WPI of wheat for the year 1980 is,

(Price of Wheat in 1980 – Price of Wheat in 1970)/ Price of Wheat in 1970 x 100

i.e. (6.10 – 5.75)/5.75 x 100 = 6.09

Since WPI for the base year is assumed as 100, WPI for 1980 will become 100 +
6.09 = 106.09.

In this way individual WPI values for the remaining 434 commodities are
calculated and then the weighted average of individual WPI figures are found out
to arrive at the overall Wholesale Price Index. Commodities are given weight-age
depending upon its influence in the economy.

2. Consumer price index

In economic the consumer price index (CPI) also retail price index is a statistical
measure of a weighted average of prices of a specified set of goods and services
purchased by wage earner in urban areas. It is a price index which tracks the prices
of a specified set of consumer goods and services, providing a measure of inflation.
The CPI is a fixed quantity price index. The consumer price index represents
changes in prices of all goods and services purchased for consumption by urban
households. User fees (such as water and sewer services) and sales and excise
taxes paid by the consumer are also included. Income taxes and investment items
(like stocks, bonds, and life insurance) are not included.

Uses of consumer price index

Apart from measuring inflation, the index is useful in indicating the need to adjust:

 Wages to keep pace with a rise in the cost of living

 Pensions
 Regulated prices

 Tax brackets to avoid increase in the rate of taxes induced by inflation.

The products and services of the CPI consumer basket are classified into more than
200 categories, arranged into 8 major groups. Major groups and examples of
categories in each are as follows:

1 Food and beverage

 Breakfast cereals, milk, coffee, chicken, wine, full service meals,

snacks.

2 Housing

 Rent of primary residence, fuel oil, and bedroom.

3 Apparel.

 Men’s shirt and sweater and women’s dresses, jewelry

4 Transportation

 New vehicle, airline fares, gasoline, motor vehicle insurance.

5 medical cares

 Prescription and medical supplies, physician services hospital

services, eyeglasses and eye care
 6 education and communication

 College fees, tuition fees postage, telephone service, accessories.

7 other goods and services

 Tobacco and smoking products, hair cut and other personal services,
and funeral expenses.

Consumer price index: how it is constructed

CPI is constructed through two kinds of data:

 Price data: using the sampling method, this data is collected for goods
and services from sales outlets in different locations and for various
times.
 Weighting data: This is the data on various types of expenditure, used
to represent the survey population from which the sample is taken.

A comparison of prices of various items under the constituents of consumer

expenditure (such as food, clothing, and shelter) is done every month with their
prices in the price- reference month. A base year is selected and changes are
presented as:

 Percentage of the previous index levels

 Annual growth rate(to give an idea of near-term to investors)

However, volatility of the index from one month to another is one of its
weaknesses. Also, some biases related to fixed CPI, such as new product and
substitution, can lead to a distortion of results. The consumer price index, along
with national income and population census, is calculated by governmental and
triggers a movement in both fixed income and the equity market.

WPI AND CPI IN INDIA

Inflation in India, measured by wholesale price index, reached 12.9% on august 2,
2008 but sharply fell to0.3% in March 2009 and negative in June 2009. The reason
for such high volatility was due to sharp rise in international commodities prices.
However, unlike WPI based inflation, CPI based inflation remained high. It did
increase with the WPI but did not come down proportionately when wholesale
prices fell. This indicates that intermediaries between consumers and wholesalers
or retailers or both have not passed on the low-cost benefits to customers and so
have enjoyed increasing margins.

Business strategies and price indices:

These indices help businesses and can prove to be an effective analytical tool for
them. These trends affect the economic policies and monetary policies of the
government and RBI respectively. High inflation rates are often followed by tight
monetary policies. In India, the WPI is related to interest rates as inflation is
measured on the basis of the WPI. High inflation rates may point towards
increasing interest rates. However, other factors also come into play while
determining interest rates but inflation is major one.

These indices play a key role in affecting sentiments. Low inflation rates may lead
to a sentiment where the investments of financed through loans are deferred
because of the expectation of lower interest rates in the future. Certain expectations
are formed based on the effects on overall economy due to movements in these
indices. For, example high inflation rates create a gloomy sentiment about the
economy and people generally tend to defer their investment in that case. Also,
consumers tend to defer their heavy expenditures during inflation due to
expectancy of fall in prices. For example housing expenditure, however other day-
to-day expenditures like grocery, energy, etc are generally not affected due to
changes in these indices. It should be noted that falling inflation never means that
prices are falling. Only negative inflation or a fall in these indices implies that
prices are falling.

These indices play a role in affecting sentiments. Low inflation rates may lead to a
sentiment where investments financed through loans are deferred because of the
expectation of lower interest rates in the future. Certain expectations are formed
based on the effects on overall economy due to movements in these indices. For
example, high inflation rates create a gloomy sentiment about the economy and
people generally tend to defer investments in that case. Also, consumers tend to
defer their heavy expenditures during inflation due to expectancy of fall in prices.
However, other day-to-day expenditures like grocery, energy, etc are generally not
affected due to changes in these indices. It should be noted that falling inflation
never means that prices are falling. Only negative inflation or a fall in these indices
implies that prices are falling. Falling inflation (positive) or decreasing rate of
increase in these indices only imply that prices are rising at a slower pace the
future. These indices also give insights whether holding an asset is justifiable or
not. For example, if an asset price rise is less than the inflation in the economy,
then this may point out towards erosion of purchasing power of the asset holder. In
other words this means that an asset holder may not be able to purchase the same
quantity of goods in the next period if price rise in asset is proportionately less than
the rise in these indices by selling that asset. So investment in assets must be made
keeping this in mind. An absolute increase in the price of the asset does not
definitely mean that the asset holder has gained in real terms. Also movements or
changes in these indices affect the futures market. High inflation rate and
increasing trend may point towards higher price in future and hence higher prices
of futures contracts. Large movements or fluctuations in these indices often open
up the opportunity for arbitrage, which is making profit due to price differences in
two markets (here different markets refer to future and spot market).

CORE INFLATION

Core inflation is a measure of inflation that excludes items such as food products
and energy, which are prone to volatile price movements. The concept of core
inflation rate was introduced by Robert J. Gordon in 1975. Core inflation measures
the change in average consumer prices after excluding from the CPI certain items
with volatile price movements. By stripping out the volatile components of the
CPI, core inflation allows us to see the broad underlying trend in consumer prices.
Core inflation is often used as an indicator of the long-term inflation trend and as
an indicator of future inflation. It is usually affected by the amount of money in the
economy relative to production, or by monetary policy. In fact, they are supposed
to be mean-reverting, implying thereby that while these prices may go up in the
short run due to some disturbance in the farm sector or oil economy, they would
tend to revert to equilibrium in the medium run. And such inflation is really out of
the purview of anyone - after all one cannot stop the OPEC from raising prices nor
one can counter the shortfall in farm production by pushing prices down
artificially for a long time.

How core inflation is measured?

There are several methods used to measure core inflation. The most common
approach used in many countries is the exclusion method, which computes core
inflation by taking out the price of a foxed, pre-specified set of items from the CPI
basket. The excluded components are considered to be either volatile or susceptible
to supply disturbance and typically consist of food and energy items. This is based
on the notion that the markets related to these goods are prone to supply shocks.

Some economist advocates the use of statistically- based methods that remove
extreme or outlier price changes (both positive and negative) from overall inflation
rate. The set of excluded items changes each month, depending on which particular
items exhibit extreme price movements. The most common statistical measures of
core inflation are trimmed mean and weighted median. Both measures are derived
from a highest-to- lowest (or positive to negative) ranking of individual price
changes for each given month. The trimmed mean measure takes the average
inflation rate after excluding a specified percentage of extreme positive and
negative price changes, while weighted median simply take the median inflation
rate which corresponds to a cumulative CPI weight of 50 percent from the highest
to lowest ranking. It is possible to use econometric techniques to estimate core
inflation by estimating or calculating a statically relationship between inflation and
other economic variables.

Monitoring core inflation

In an economy facing inflationary pressure, the central bank typically aims at

controlling the core inflation rate, as this is easier to control than the headline rate.
Any change in the interest rate policy should consider core inflation, as an increase
in the interest rate might hamper growth. This can further aggravate the
inflationary situation.

Uses of Core Inflation

Core inflation serves three major purposes:

 Forecasting future inflation: Predictions of future inflation based on core
measures are more accurate than predictions based on headline inflation.
 Measuring the current trend inflation rate: The inflation rate reflects both
permanent and transitory components. By stripping away the short-term
movements, the current trend inflationary rate can be measured more effectively.
 Stabilizing the economy: This is done by reducing variations in the output
and employment.

Statistical agencies across the world typically use the core inflation rate as a
supplement to the headline inflation rate and publish them together. The countries
that use the core inflation rate as the operating base for monetary policies include
Canada, the Czech Republic, Thailand, Finland and South Africa.

Money supply and inflation

Definition

Money supply refers to the stock of money held by people in spending form. It is
one of the important components in formulating economic policy. In another word
it means the total supply of money in circulation in a given country's economy at a
given time. There are several measures for the money supply, such as M1, M2, and
M3. The money supply is considered an important instrument for controlling
inflation by those economists who say that growth in money supply will only lead
to inflation if money demand is stable. In order to control the money supply,
regulators have to decide which particular measure of the money supply to target.
The broader the targeted measure, the more difficult it will be to control that
particular target. However, targeting an unsuitable narrow money supply measure
may lead to a situation where the total money supply in the country is not
adequately controlled.

Quantity theory of money

Value of money and the price level

Value in economics means value –in-exchange. The value of a commodity means

what it can be exchanged for or what it can buy. It means the purchasing power of
a commodity. The purchasing power depends on the prevalent price level. If the
prices are high, money will buy less and its value will be low. Conversely, if the
price level is low, the value of money is high. The value of money is thus inversely
proportional to the price level, or the value of money is the reciprocal of the price
level.

Quantity theory of money was put forward by Irving fisher. Many economists
believed that with increase in quantity money the general price level also increase.
They believed that the greater the quantity of money, higher the level of prices and
vice versa. Therefore, the theory which linked the prices with quantity of money
came to known as quantity theory of money.

The quantity theory of money seeks to explain the value of money in terms of
changes in its quantity. Stated in simple form, the quantity theory of money says
that the level of prices varies directly with quantity of money. “Double the quantity
of money, and other things being equal, prices will be twice as high as before, and
the value of money one-half. Half the quantity of money and other things being
equal, prices will be one-half of what they were before the value of money
doubles”. In another it can be stated as, the price level rises proportionately with a
given increase in the quantity of money. Conversely, the price level falls
proportionately with a given decrease in the quantity of money, other things the
same. There are many forces that determine the value of money and the general
price level. The general price level in a community is influenced by the following
factors;

 The volume of trade and transaction

 The quantity theory of money
 Velocity of circulation of money

The first factor, the volume of trade and transaction, depends on the supply of
goods and services to be exchanged. The greater the amount or supply of goods
and services in the economy, the larger the number of transaction and trade, and
vice verse.

The second factor in the determination of general level of prices is the quantity of
money.
The third factor influencing the price level is the velocity of circulation of money.
The velocity of money is the number of times a unit of money changes hands
during exchanges in a year.

Illustration

Suppose in a country there is only one good, wheat, which is to be exchanged. The
total output of wheat is 2,000 quintal in a year. Further suppose that the
government has issued money equal to Rs 25,000 and no credit is issued by banks.
Assume that one rupee is used four times in a year for exchange of wheat. The
velocity of circulation of money would be four. Under these circumstances, 2,000
quintal of wheat are to be exchanged for Rs 1, 00,000, (25,000*4) the price of
wheat will be 1, 00,000/2,000 that comes to Rs 50 per quintal. If the quantity is
doubled to Rs 50,000 while the output remains same 2,000 quintal the price of
wheat will rise to 2,00,000/2,000 =Rs 100 quintal. This is because of increase in
the quantity of money.

If the volume of transaction output to be exchanged remains constant, the price

level rises with the increase in the quantity of money.

QTM in a Nutshell
The quantity theory of money states that there is a direct relationship between the
quantity of money in an economy and the level of prices of goods and services
sold. According to QTM, if the amount of money in an economy doubles, price
levels also double, causing inflation (the percentage rate at which the level of
prices is rising in an economy). The consumer therefore pays twice as much for the
same amount of the good or service. 

The Theory’s Calculations

In its simplest form, the theory is expressed as:
 
MV = PT (the fishers equation)

Each variable denotes the following:

M =money supply
V = Velocity of Circulation (the number of times money changes hands)
P = Average Price Level
T = Volume of Transactions of Goods and Services 

  It is built on the principle of "equation of exchange": 

Amount of Money x Velocity of Circulation

= Total Spending

QTM Assumptions
QTM adds assumptions to the logic of the equation of exchange. In its most basic
form, the theory assumes that V (velocity of circulation) and T (volume of
transactions) are constant in the short term. These assumptions, however, have
been criticized, particularly the assumption that V is constant. The arguments point
out that the velocity of circulation depends on consumer and business spending
impulses, which cannot be constant.  

The theory also assumes that the quantity of money, which is determined by
outside forces, is the main influence of economic activity in a society. A change in
money supply results in changes in price levels and/or a change in supply of goods
and services. It is primarily these changes in money stock that cause a change in
spending. And the velocity of circulation depends not on the amount of money
available or on the current price level but on changes in price levels.  

Finally, the number of transactions (T) is determined by labor, capital, natural

resources (i.e. the factors of production), knowledge and organization. The theory
assumes an economy in equilibrium and at full employment.  

Essentially, the theory’s assumptions imply that the value of money is determined
by the amount of money available in an economy. An increase in money supply
results in a decrease in the value of money because an increase in money supply
causes a rise in inflation. As inflation rises, the purchasing power, or the value of
money, decreases. It therefore will cost more to buy the same quantity of goods or
services.  

Money Supply, Inflation and Monetarism

As QTM says that quantity of money determines the value of money, it forms the
cornerstone of monetarism. Monetarists say that a rapid increase in money supply
leads to a rapid increase in inflation. Money growth that surpasses the growth of
economic output results in inflation as there is too much money behind too little
production of goods and services. In order to curb inflation, money growth must
fall below growth in economic output.  This premise leads to how monetary policy
is administered. Monetarists believe that money supply should be kept within an
acceptable bandwidth so that levels of inflation can be controlled. Thus, for the

Near term, most monetarists agree that an increase in money supply can offer a
quick-fix boost to a staggering economy in need of increased production. In the
long term, however, the effects of monetary policy are still blurry. 

Less orthodox monetarists, on the other hand, hold that an expanded money supply
will not have any effect on real economic activity (production, employment levels,
spending and so forth). But for most monetarists any anti-inflationary policy will
stem from the basic concept that there should be a gradual reduction in the money
supply. Monetarists believe that instead of governments continually adjusting
economic policies (i.e. government spending and taxes), it is better to let non-
inflationary policies (i.e. gradual reduction of money supply) lead an economy to
full employment.  

Keynesian view of inflation

As opposed to the classic, who view inflation as a problem of ever-increasing

money supply, Keynesian concentrate on the institutional problems of people
increasing their price level. Keynesian argues that firms raise wages to keep their
workers happy. Firms then have pay for that and keep making a profit by
subsequently raising prices. This cause both increases in prices and wages and
demands an increase in money supply to keep the economy running. So the
government then issues more and more money to keep up with inflation. This
differs from the classical model.

Food inflation
Food is one of the most important basic amenities for every section of the society.
Every person demands food for survival. It has become necessity. Today, the
biggest concern facing the country is raising prices. There is uproar in Parliament
as political parties jostle to grab as much mileage as possible from the
government's apparent failure to curb runaway inflation, as they try to sidle up to
the common man who has been worst hit by skyrocketing prices.
Food inflation is hovering near 20 per cent. Everyone is facing the brunt of rising
prices. Food prices are soaring . . . all essential items like vegetables, oil, milk,
sugar are getting costlier. Rentals and real estate rates have almost doubled in just a
few months in most cities. The real estate prices are at record highs making life
miserable, especially for people who have migrated to cities for jobs.
Inflation hits badly as prices keep rising. One ends up spending more money for
things that could buy for les earlier. What one could buy for Rs 100, some months
ago, would now cost nearly double. As a result, ones savings will come down. As
prices rise, the purchasing power of money goes down too.
Inflation hits retired folk and people with fixed incomes very badly. Inflation
destabilizes the economy as consumers and investors change their spending habits.
Economists attribute inflation to a demand-pull theory. According to this, if there
is a huge demand for products in all sectors, it results in a shortage of goods. Thus
prices of commodities shoot up.
The rising prices of food products, manufacturing products, and essential
commodities have pushed inflation rate further in India
 Food inflation scenario in India

India has been witnessing high food inflation since many years. Despite all the
measures taken by the government to control inflation it is inching upward
persistently. Since 2008, when the economy was under low growth conditions,
food articles like rice, wheat, pulses, vegetables, potatoes, onion, milk etc had
become dearer by 30 percent. In terms of year on year, food inflation reached at
17.97 percent. The rise in price of food articles had been tied to the rise in prices
of fuel.. Inflationary trends cannot be fully attributed to petrol and high speed
diesel oil prices. Moreover, the record food grains production & procurement last
year has been widely touted as being sufficient to manage domestic food demand.
Yet still, the country has been witnessing unprecedented rise in prices of food
articles, and the policy makers are being forced to rethink inflation management
strategies; various reasons have been attributed to this trend, these include:

Firstly, food inflation is a direct result of the late monsoons, drought and flood in
some regions of the country. Consequently, Kharif output has been officially stated
to be lower than last year, with significant deficiencies in production of food
grains, pulses, and oil seeds. Secondly, besides rice and wheat, for which the
country has sufficient stocks, carryover stocks for pulses, oilseeds and sugar are
not adequate to help country tide over this predicament; essentially indicating a
supply driven crisis. Thirdly, government’s handling of public distribution system
in the current fiscal especially in the light of drought situation; fourthly, structural
drivers in form of  implementation of NREGA, which, though worthwhile, is
essentially a consumption expenditure, consequently resulting in too much money
floating in the system; and fifthly, large number of intermediaries in agriculture
supply chain & their unrealistic margins thereof. Over the top inflation currently
being registered is said to be happening primarily because of the interplay of the
above factors.

India is currently experiencing one of the highest inflationary episodes in the

history of the country. Currently, on the week ending June 12, 2010, the year-on-
year food inflation rate, as measured by the Wholesale Price Index was 16.9%
rising from 16.12 percent in the previous week. This double digit inflation rate for
food articles has been persisting for a long period of time since last year. It was
told by the government and other policy makers that inflation was mainly in the
food articles because of the last year's drought. Once the kharif crop is harvested,
supply will get augmented and hence the food inflation rate and the overall
inflation rate will come down. This has not happened. The overall inflation rate for
the month of May 2010 was 10.16%, rising from 9.59% in April 2010. What is
even more worrying is that not only is it the case that food price inflation is rising
but additionally inflation rate for manufactured articles has also increased in May
2010 to 6.41%, which was only 2.18% in May last year.

Causes of High Food Inflation in India

Inflation is caused by an excess demand of commodities. This excess demand can

happen in two alternative ways. Firstly, an increase in demand with the supply
remains intact. Secondly, even with demand remaining the same if supply falls
then also there will exist excess demand and hence inflation. In India, ever since
the policies of neo-liberal globalization have been adopted, there has been a steady
decline in the growth rate of food grains. The growth rate of food grains during
1993-94 to 2003-04 was only 0.69% which further reduced to 0.32% during 2004-
05 to 2009-10. This meager rate of growth of food grain should be compared with
a population growth rate of 1.4%. In other words, growth of per capita food grain
production, which is the difference between growth rate of food grains and growth
rate of population, is negative, which essentially means that per capita food grain
production is declining in India.

Main causes are demand-supply factor.

This is the most important factors in the rise in food prices in recent years. Among
the demand side factors are growing world population and strong income growth in
emerging economies around the globe. The latter factor is associated with dietary
changes toward higher-quality food such as meat and dairy products. Production of
meat and dairy products requires large amounts of grain in the form of livestock
feed. In order to produce a single kilogram of beef it may require as much as 7
kilogram of grains, hence as caloric intake shifts to more protein, more and more
grain is demanded for the same amount of calories for human consumption.
Another important structural demand factor is the competing use of food grain to
produce ethanol as a substitute for oil. Biofuel demand is rising and is leading to
diversion of grains, soybean, sugar, and vegetables oil from use as food or feed.
On supply side, urbanization and competing demand for land for commercial as
opposed to agricultural purposes is an important factor, as the increasing scarcity
of fresh water foe agriculture. Cropping patterns away from food to Biofuel may
also reduce the available supply of land devoted to food. Neglect of investment in
agricultural technology, infrastructure, and extension is also programme is also to
blame for the tepid supply growth. Pricing policies may have played a role by
discouraging farmers from increasing marketed supplies. Also, poor and marginal
farmers may not have the means to respond and may also be hurt if they are net
buyers rather than net sellers of food. The rise in costs of input related to record-
high fuel prices and rising costs of power for irrigation pumps also are factors.
Inadequate post harvest milling and storage facilities entail losses as does poor
infrastructure.

The Fallacy of the Government's Claim on Inflation

Contrary to the above mentioned reasons for the high food price inflation in India,
the government has time and again come up with fallacious arguments for the
causes and the remedies for inflation. The most concrete expression of the causes
of inflation was mentioned by the Government in the President's speech, delivered
on the first day of the last Budget Session of Parliament on 22nd February 2010. In
that speech the President said,

“Higher prices were inevitable given the shortfall in domestic production and
prevailing high prices of rice, cereals and edible oils globally. They are also to
some extent a reflection of the implementation of our schemes of inclusive growth
involving payment of higher procurement prices to our farmers and the impact of
higher public spending on programmes of rural development, which have
successfully raised incomes in rural areas.”
The above quoted statement from the President’s speech has three claims. Firstly,
the claim is that we have food security in the country. Secondly, the higher prices
are a result of a fall in domestic production and international high prices in various
products. Thirdly, the higher prices are also a result of providing more purchasing
power to the poor through the various schemes like NREGA. This is the basic crux
of the Government's position on the question of inflation. Not only are these
adduced reasons wrong, they also reflect the complete neo-liberal economic
thinking of the Government.

Policies of Globalization and Agriculture Production

The freedom movement in India promised the peasantry protection from the
imperialist loot of agriculture which occurred during the colonial period.
Therefore, after independence the Indian government protected the peasantry
through providing state support in the form of investment in Green Revolution,
irrigation, extension services for agriculture, limited land reforms etc. But with
neo-liberal globalization, the diktat of finance capital entails a situation where this
support of the Government for the peasantry cannot continue because of the
following. Firstly, globalization also entails opening up the agricultural sector for
trade. As a result, the Indian peasantry got exposed to the volatility of global
commodity prices. Moreover, with a higher price for cash crops like cotton, land
from food grain production was diverted for producing cash crops like cotton. In
the event of a crash in the prices of such crops since the 1990s, the peasantry got
pauperized, which is a major reason for farmers' suicides in the country. Secondly,
subservience to neo-liberal globalization precludes the possibility of active state
intervention in the economy, including agriculture. Therefore, the support that the
state provided to agriculture declined drastically since the advent of neo-liberal
reforms. Thirdly, there has been an attack on the landholding of the peasantry
through the policies of setting up of SEZs and other such projects. Fourthly,
irrigation still predominantly remains rain-fed and hence dependent on monsoons
since the government is reluctant to invest majorly in agriculture. Fifthly, there has
been a massive increase in input prices of fertilizers, pesticides, seeds etc again
because the government under the diktat of IMF-World Bank has sold fertilizer
factories and opened up the economy for MNCs like Monsanto, Cargill etc.
Sixthly, policies of financial liberalization have drastically reduced agricultural
credit to the farmers. All this has made agricultural activities an unprofitable
enterprise. As a result, agricultural production in general and food grains
production in particular has suffered.

Economic growth and inflation

Economic growth is the increase of per capita gross domestic product (GDP) or
other measure of aggregate income. It is often measured as the rate of change in
GDP. Economic growth refers only to the quantity of goods and services produced.

Economic growth can be either positive or negative. Negative growth can be

referred to by saying that the economy is shrinking. Negative growth is associated
with economic recession and economic depression.

Today India being the most emerging economy is growing at the fast growth rate.
The Indian economy has been propelled by the liberalization policies that have
been instrumental in boosting demand as well as trade volume. The growth rate has
averaged around 7% since 1997 and India was able to keep its economy growing at
a healthy rate even during the 2007-2009 recession managing a 5.355% rate in
2009 (India growth GDP). The biggest boon to the economy has come in the shape
of outsourcing. Its English speaking population has been instrumental in making
India a preferred destination for information technology products as well as
business process outsourcing. The economy of India is as diverse as it is large,
with a number of major sectors including manufacturing industries, agriculture,
textiles and handicrafts, and services. Agriculture is a major component of the
Indian economy, as over 66% of the Indian population earns its livelihood from
this area. Inflation is usually a cause of uncertainty in the economy. Low inflation
causes uncertainty among the producers and high inflation eventually leads to
uncertainty among the consumers. It has been rightly said that for a developing
country like India, some inflation acts as the motivator for the producers to
perform better, but at the same time acts as the repellent for the customers. Hence
for the substantial economic growth it becomes mandatory to maintain the stable
inflation rate, which ranges from 3.5-4.5%. It was only during the period of
economic crisis in India that India faced the problem of very high inflation. In the
recent times one could witness the highs in the inflation rate. It is being
experienced when we are targeting the economic growth in the double digits. The
high inflation rate has no doubt reduced the speed of economic growth.

Inflation is nothing but the rise in the prices. It happens as a result of

disequilibrium in the demand and supply. The supply of money is relatively more,
thus demand for goods increases to a greater extend. But the problem arises
when the supply of goods is unable to match the rise in the demand for the
goods. At this moment Inflation acts as a trap… it is expected that due to the
inflation, the investment plan will be postponed and ultimately it is the
production that would suffer. There is negative correlation between inflation and
economic growth. Inflation not only reduces the level of business investment, but
also the efficiency with which productive factors are put to use. There are several
factors affecting the GDP, though there should be efficient and effective factors to
reflect a robust and sustainable growth rate. The economy no doubt is flourishing,
but the rising trend in inflation and apprehensions relating to its control have
reduced the pace of the economic growth. The economic growth has lead to the
rise in the levels of investment, production, and employment and ultimately there
was rise in the level of income. The purchasing power of the customers has
increased to the greater extent. They have money in their hands to demand what
they desire, but the market is not yet ready to supply them enough. This difference
in the demand for and supply of goods has caused inflation. Therefore, as one can
foresee, the suitable measure to control inflation gradually would be to increase the
supply of goods, so as to match the demand of the consumers and gradually
increase the value of money.

Effects of inflation
1Investment:
If the price of goods increases and people has to compensate for the increase in
price, they usually make use of their savings. In the event when savings are
depleted, fund for investment is no longer available. An individual tends to invest,
only if savings of an individual is strong and has sufficient money to meet his daily
needs.

2 Interest rates:
Whenever inflation reigns supreme, it is a well known fact that the value of money
goes down. This leads to decline in the purchasing power. In the event, when the
rate of inflation is high, the interest rates also rise. With increase in both
parameters, cost of goods will not remain the same and consequently people will
have to shell out more money for the same goods.

3 income distribution

During inflation prices of all goods and services or of different sectors do not
increase at a uniform rate. Entrepreneurs usually earn more profits unless the profit
is nullified by the increase in cost. Investors in financial assets like government
securities, bonds or any investment which earn fixed income find their real income
erodes .speculators tend to gain.

4 employments

Inflation provides the incentives to produce and invest. Employment opportunities

increase with additional investment. To provide more employment the price level
should be allowed to increase. An inverse relationship therefore can be established
between inflation and unemployment. If there is stability in price than it should be
prepared for higher percentage of unemployment, conversely for low percentage of
unemployment a higher level of inflation is to be tolerated. Such relationship is
explained by Prof.A.W.Phillips. The Phillip curve explains the tradeoff between
inflation and unemployment.
5 farmers

During inflation farmers are net gainer because they can sell their commodity
product at higher rate and dispose off their old debt, but it not the same case in
every commodity. Some commodities may not be as high as industrial goods, as
the demand for former is comparatively inelastic. It is likely that the term of the
trade is unfavorable.
 Measure to control inflation

Inflation must be controlled at an appropriate level. Uncontrolled inflation may

turn into hyper inflation. Since inflation occurs due to disequilibrium in aggregate
demand and supply, it would be controlled by correcting the forces which cause
such disequilibrium.

Monetary policy

Monetary policy plays an important role in the economic development of a

country. It is basically concerned with measures undertaken by the central bank of
the country to control the money market with the view to influence the working of
the economy.H.G.Johnson defines monetary policy as “policy employing central
banks control of the supply of money as an instrument for achieving the objectives
of the general economic policy.

Objectives of monetary policy

1 to regulate monetary growth and maintain price stability

2 to ensure adequate expansion in credit
3 to assist economic growth
4 to encourage the flow of credit into priority and neglected sectors
5 to strengthen the banking system
Instruments used to control credit;

Quantitative or general measures: it is used for changing the total volume of credit
in the economy. It consist of

1 bank rate policy- it is the official interest rate at which the central bank
rediscounts the approved bills held by a commercial bank.

2 open market operations- OMO imply deliberate and direct sales and purchases of
securities and bills in the open market by the central to control volume the credit.

3variable reserve requirement- variable reserve requirement consist of two types of

reserve;

 cash reserve ratio- it refers to that portion of total deposits, which a

commercial bank has to keep with RBI in form of cash reserve

 Statutory liquidity ratio- it refers to that portion of total of deposits of

commercial banks, which it has to keep with itself in the form of liquid
assets.

Qualitative measures: it used regulates credit for specific purposes. It consist of

1 Margin requirement- margin requirements is the difference between

securities offered and amount borrowed from banks.
2 consumer credit regulations- the regulation of consumer credit consist of
laying down payments and maximum maturities of installment credit for the
purchase of specified consumer durable goods.
 3 issue of directives- the central bank also uses directives in the form of oral,
written statements, appeals, or warnings, to various commercial banks for
credit control.
4 rationing of credit- Rationing of credit is a selective method adopted by the
central bank for controlling and regulating the purpose for which credit is
granted or allocated by commercial banks.
6 moral suasion - it is a psychological means and purely informal and milder
form of selective credit control. In moral suasion central bank persuades and
morally request to the commercial banks to co-operate with the general
monetary policy.