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According to Pigou, “Inflation exists when money income is expanding more than in
proportion to increase in earning activity.”
CONCEPT OF INFLATION
The other concept is price inflation, which is an increase in the overall level of prices
for goods and services. The relationship between the two is the relationship of cause
and effect. Monetary inflation causes price inflation. But while almost everyone sees
price inflation when it happens, few people notice the monetary inflation that is
causing it. And so they tend to blame the producers of goods and services for higher
prices - rather than the money-creating government that is the true culprit.
For example:
➢ A movie ticket was for a few paisas in my dad’s time. Now it is worth Rs.50.
➢ My dad’s first salary for the month was Rs.400 and over his years it has now
become Rs.75, 000.
This is what inflation is, the price of everything goes up. Because the price goes up,
the salaries go up.
If you really thing about it, inflation makes the worth of money reduce. What you
could buy in my dad’s time for Rs.10, now a days you will not be able to buy for
Rs.400 also. The worth of money has reduced! If this is still not clear consider this,
when my father was a kid, he used to get 50paise pocket money. He used to use this
money to go and watch a movie (At that time you could watch a movie for 50paise!)
Now, just for the sake of understanding assume that my dad decided in his
childhood to save 50paise thinking, that one day when he becomes big, he will go for
a movie. Many years pass. The year now is 2006. My dad goes to the theater and
asks for a ticket. He offers the ticket-booth-guy at the theater 50paise and asks for a
ticket. The ticket booth guy says, “I am sorry sir, the ticket is worth Rs.50. You will
not be able to even buy a “paan” with the 50 paisa!!”
The moral of the story is that, the worth of the 50paise reduced dramatically.
50paise could buy a whole lot when my dad was a kid. Now, 50paise can buy
nothing. This is inflation. This tells us two important things.
Firstly:
Do not keep your money stagnant. If you just save money by putting it your safe it
will loose value over time. If you have Rs.1000 in your safe today and you keep it
there for 10years or so, it will be worth a lot less after 10 years. If you can buy
something for Rs.1000 today, you will probably require Rs.1500 to buy it 10 years
from now. So do not keep money locked up in your safe.
Always invest money.
If you can’t think where to invest your money, then put it in a bank. Let it grow by
gaining interest. But whatever you do, do not just lock your money up in your safe
and keep it stagnant. If you do this, you will be loosing money without even knowing
it. The more money you keep stagnant the more money you will be loosing.
Secondly:
When investing, you have to make sure that the rate of return on your investment is
higher than the rate of inflation.
As we said earlier, the prices of everything go up over time and this phenomenon is
called inflation.
The question is: By how much do the prices go up? At what rate do the prices do
up?
The rate at which the prices of everything go up is called the "rate of inflation". For
example, if the price of something is Rs.100 this year and next year the price
becomes approximately Rs.104 then the rate of inflation is 4%. If the price of
something is Rs.80 then after a year with a rate of inflation of 4% the price go up to
(80 x 1.04) = 83.2
So, when you make an investment, make sure that your rate of return on the
investment is higher than the rate of inflation in your country. In our county India,
for the year 2005-2006 the rate of inflation was 4% (Which is really low and
amazing!). This rate keeps changing every year. The finance minister generally
gives the official statement on the inflation rate of the country for a particular year.
If you invest Rs.100 in the market today and you make money at a 3% "rate of
return" in one year you will have Rs.103. But now, since the rate of inflation is at
4%, an item costing Rs.100 today will cost Rs.104 a year from now. So what you can
buy with today’s Rs.100, you will only be able to buy with Rs.104 a year from now.
But the Rs.100 that you invested has grown only at a 3% rate of return and so it is
worth Rs.103. In effect, you are loosing money!
So in conclusion, the rate of return on your investments, have to be higher than the
rate of inflation.
From the above paragraphs you can note how silently, inflation eats into your
money. You would not even know about it and your money would sit loosing value
for no fault of yours.
KINDS OF INFLATION
➢ Moderate Inflation
➢ Galloping Inflation
➢ Hyper Inflation
1. Moderate Inflation:
A ‘single digit’ rate of annual inflation is called ‘moderate
inflation’ or creeping inflation. During the period of moderate inflation
price increases, but at a moderate rate. The moderate rate may vary from
country to country. However an important feature of moderate inflation
is that it is predictable and people hold money as a store of value. By this
definition India has had a moderate rate of inflation during the post
independence period except in few years.
2. Galloping Inflation:
Very high rate of inflation is called galloping inflation. How
high should be the rate of inflation to be called a galloping inflation is not
defined precisely? According to Baumol and Blinder galloping inflation
refers to an inflation that proceeds at an exceptionally high rate. They do
not specify at what rate of inflation is exceptionally high. A country with
900 percent inflation will have devastating effects, whereas countries with
20-30 percent can mange without pressing the alarm bell. Some examples
of galloping inflation, i.e., the annual average rate of inflation, during
1980-91 are as follows:
➢ Argentina- 416.9%
➢ Brazil- 327.6%
➢ Mexico- 66.5%
➢ Peru- 287.3%
➢ Yugoslavia- 123%
1. Hyper Inflation:
CAUSES OF INFLATION
1. Demand-pull inflation.
2. Cost-push inflation
A group of economists holds the opposite view that the process
of inflation is initiated not by an excess of general demand but by an
increase in costs, as factors of production try to increase their share of
total product by raising their prices. Thus, it has been viewed that a
rise in prices is initiated by growing cost factors. Therefore, such a
price is termed as “cost push inflation” as prices are being pushed up
by the rising factor cost.
Cost push inflation is induced by wage inflation process. It is
believed that wages constitute nearly seventy percent of the total cost
of production.
This is specially true for a country like India, where labour
intensive techniques are commonly used. Thus rise in wages leads to a
rise in the total cost of production and a consequent rise in the price
level, because fundamentally, prices are based on costs. Any
autonomous increase in costs, such as rise in price of imported
components or an increase in indirect taxes (excise duties, etc), may
initiate a cist push inflation.
MEASURES TO CONTROL INFLATION
1. Monetary Policy set by RBI
• GOVERNMENT EXPENDITURE
• PUBLIC BORROWINGS
1. Zimbabwe: 355,000%
The inflation in Zimbabwe for the month of March 2008 rose to 355,000%! Yes,
355,000 per cent! It more than doubled from the February figure of 165,000%.
Economists say that it is a miracle that the Zimbabwean economy is still surviving
and prices have been rising to unprecedented proportions. Inflation surged between
February and March following the sudden rise in money supply that flooded the
economy to finance the 2008 elections. Apart from this food and non-alcoholic
beverages continued to drive up inflation.
Almost 80% of the nation is unemployed. The Zimbabwean central bank has
introduced $500 million bearer cheques (or currency notes) for the public, and $5
billion, $25 billion, $50 billion agro-cheques for farmers. Just last fortnight the
nation had introduced $250 million bearer cheques.
A sausage sandwich sells for Zimbabwean $50 million. A 15-kg bag of potatoes cost
Zimbabwean $260 million. But then, Zimbabwean $50 million is roughly equal to
US$ 1!
2. Iraq: 53.2%
War-torn Iraq is also facing a huge problem, not only on the political front but
also on the economic one. Inflation in Iraq is running amuck. It currently stands at
53.2%.
Rising oil prices, political instability, terrorism and the other post-conflict dynamics
have led to inflation in the nation rise to unmanageable proportions
Some hurried counter-by the Iraqi central bank to curb inflation too have added
fuel to the fire.
3. Guinea: 30.9%
Guinea is also one of the world's poorest countries. The inflation in the nation is at
30.9%.
Although blessed with rich mineral wealth -- with huge iron ore, gold and diamond
deposits -- Guinea has been languishing as one of the poorest nations on earth with
large-scale unemployment, lack of industry and infrastructure dogging it.
5. Yemen: 20.8%
Yemen is going through terrible times. The Yemini economy is experiencing an
inflation rate of 20.8%.
More than 87% of Yemenis live for less than $2 a day. About 52% of children less
than 5 years old suffer from malnutrition.
Most of the people are engaged in agriculture, followed by the services and
infrastructure sectors, while unemployment is rampant at 35 per cent.
6. Myanmar: 20%
Myanmar is one of the world's poorest nations. It has suffered immensely under
military rule for decades and has been categorised as one of the 'least developed
countries' in the world by the United Nations. Its inflation rate is at 20%.
The economy of Myanmar is mostly controlled by the military junta leaving little
room for private entrepreneurship or growth.
The military regime has also decided to do away with all reforms suggested by
economists, throwing the nation's economy into further turmoil.
7. Uzbekistan: 19.8%
Uzbekistan is slowly moving from a somewhat closed to a market-based economy.
The economic reforms have helped achieve some growth, but not nearly as much as
the nation would ideally like to enjoy.
Also, lack of infrastructure, tight state control over the economy, occasional
skirmishes with neighbouring nations, and an unstable political environment have
seen inflation rise sharply here.
The nation's inflation rate is at 19.8% currently.
8. Democratic Republic of Congo: 18.2%
Global investors do not feel that the Republic of Congo has a foreigner-friendly
investment environment as it does not offer any incentive to the investor. Added to
that a disorganized yet costly work force, high electricity costs, irregular supply of
raw material, occasional civil unrest, political instability have only added to Congo's
woes.
And even as the nation grapples with its myriad problems, the Congolese economy
has been going from bad to worse. And its current rate of inflation is 18.2%.
9. Afghanistan: 17%
Afghanistan has long been a theatre of conflict and that has affected its economy
adversely. Perpetual battles, an environment of fear, lack of infrastructure, industry
and services has led to a once-proud nation turn into one of the world's poorest. The
inflation rate in Afghanistan is at 17%.
The influx of billions of dollars of international aid has not really helped the
economy much, although it is supposed to be much better now than it was in 2002.
10. Serbia: 15.5%
Serbia's fragile economy, which mostly rests on agriculture, services and some
manufacturing activity, has been going through a reform process for a long time.
However, economic sanctions that were imposed on the nations in the 1990s have hit
Serbia's economy so hard that its myriad economic problems continue to this day.
Unemployment is rampant, foreign investment is down to a trickle, foreign
exchange reserves are low, and political instability are keeping good projects from
taking off.
Although the nation is growing at a robust pace, the rising inflation -- currently at
15.5% -- is hurting the Serbian economy.