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INFLATION

Presentation
By

Dr.N.Moogana Goud
Prof and Director(MBA Programme)
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INFLATION

What is inflation?
Inflation measures the annual
rate of change of the general
price level in the economy.
Inflation is a sustained increase in
the average price level.
Focus here on the overall level of
prices throughout the economy
rather than prices in one particular
market or industry.
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INFLATION
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INFLATION

Inflation and the Price Level

 When prices rise, the value of money falls.
 There is an inverse relationship between the
price level and the internal purchasing power
of money.
 People can protect themselves against the effects
of inflation by investing in financial assets that
give a rate of return at least equal to the rate of
inflation.
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INFLATION
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INFLATION

Hyperinflation is
extremely rare. Recent
examples include Argentina,
Brazil, Georgia and Turkey
(where inflation reached
70% in 1999). The classic
example of hyperinflation
was of course the rampant
inflation in Weimar
Germany between 1921 and
1923.
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INFLATION

When hyperinflation occurs, the value of money

becomes worthless and people lose all confidence
in money both as a store of value and also as a
medium of exchange.
DEFLATION
 Deflation refers to a decrease in the general
price level of the economy. A fall in prices in
particular markets, such as housing, share prices
or the market for electronic goods or textiles is
not the same as economy-wide deflation.  
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INFLATION
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INFLATION
 Most economists believe that disinflation or falling
inflation is beneficial for the economy. A stable price
level can lead to better decisions and a more efficient
use of scarce resources.
 A decline in prices after an improvement in
productivity is allows companies to cut costs and
prices, thereby raising living standards.
 The type of deflation that analysts fear is the kind that
is broadly-based throughout the economy, long-
lasting, and symptomatic of a weak economy stuck in
recession.
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INFLATION

DEMAND PULL INFLATION

occurs when total demand for goods and services
exceeds total supply.
happens when there has been excessive growth in
aggregate demand and there is an inflationary gap.
it is often monetary in origin.
The phrase that is often used is that there is "too
much money chasing too few goods"
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INFLATION

Demand pull inflation can be illustrated graphically using

aggregate demand and aggregate supply analysis.
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INFLATION

 Aggregate supply (AS) shows the total supply of goods

and services
 When aggregate demand (AD) increases from AD to AD1
the economy is still operating at relatively low levels of
capacity. Output can expand relatively easily so firms will
only implement small increases in prices from P to P1.
 When aggregate demand increases from AD1 to AD2 the
economy is moving towards the full employment of
factors of production.
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INFLATION

Main causes of increased aggregate demand:

 A depreciation of the exchange rate increases the price
of imports and reduces the foreign price exports
 A reduction in direct or indirect taxation
 Rapid growth of the money supply
 Faster economic growth in other countries
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INFLATION

COST PUSH INFLATION

 It when firms increase prices to maintain or protect
profit margins after experiencing a rise in their costs of
production.
 inflation can also come from external sources, for
example a sudden rise in the cost of crude oil or other
imported commodities, foodstuffs and beverages.
 Fluctuations in the exchange rate .
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INFLATION

This can be shown by an inward shift of the short run

aggregate supply curve which leads to a contraction in
aggregate demand and a fall in real output, but an increase
in the general price level.
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INFLATION

The main causes of cost push inflation are:

 Rising imported raw materials costs perhaps caused by
inflation in other countries or by a fall in the value of the
pound in the foreign exchange markets
 Firms may decide to pass on this to their customers
 Higher indirect taxes imposed by the government - for
example a rise in the specific duty on alcohol and
cigarettes, an increase in fuel duties or a rise in the
standard rate of Value Added Tax.
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INFLATION
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INFLATION

INFLATIONARY GAPS
 When aggregate demand exceeds an economy's
productive potential there is an inflationary gap. We tend
to see rising inflation and a worsening trade situation at
these times.
 This situation occurs when the economy has been growing
for some time leading to a build up of inflationary
pressure as demand rises.
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INFLATION
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CONTROLLING AN INFLATIONARY GAP

 The government may use monetary and or fiscal
policy to help reduce the size of the inflationary gap.
 An improvement in the supply-side performance of
the economy would also achieve this.
• Monetary Policy: Higher interest rates to curb
consumer demand
• Fiscal Policy: A rise in the burden of taxation to
reduce real disposable incomes
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INFLATION

 Supply-side Policy: Measures to increase productivity

and efficiency. This leads to a rise in aggregate supply and
reduces the amount of excess demand in the long run.
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MEASURES TO CONTROL INFLATION

“If inflation is allowed to gain a footing, it is only likely to

get out of control”
Broadly speaking anti-inflationary measures are five
Monetary measures
fiscal measures
wage control
price control, and
Appreciation of Exchange Rate
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MEASURES TO CONTROL INFLATION

1. MONETARY MEASURES
 control the growth of demand through an
increase in interest rates and a contraction in the
real money supply.
 These measures include the Bank rate policy,
Open market Operation, Variable cash
Reserve Ratios and selective credit control
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MEASURES TO CONTROL INFLATION

BANK RATE POLICY:

The effects of higher interest rates
 reduce aggregate demand in three main ways;
 Discouraging borrowing by both households and
companies.
 Increasing the rate of saving (the opportunity cost of
spending has increased)
 A rise in real interest rates should reduce the demand for
lending and therefore reduce the growth of broad money.
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MEASURES TO CONTROL INFLATION

OPEN MARKET OPERATION:

 It refers to buying and selling of Government securities in
the money market.
 During Inflation selling of securities reduces the supply of
money and brings down the demand for goods and
services.
 Whereas in case of Deflation buying of securities
increases the supply of money causing increased demand
for goods and services.
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MEASURES TO CONTROL INFLATION

CASH RESERVE RATIO

The Centrel Bank can immediately reduce the amount of
credit which commercial banks can create.
THE SELECTIVE CREDIT CONTROL MECHANISM
It is particularly the consumer credit regulation. Therefore
regulating the consumer credit proves to be an effective
measure to mitigate the inflationary pressure.
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MEASURES TO CONTROL INFLATION

2. FISCAL MEASURES
• Higher direct taxes (causing a fall in disposable income)
• Lower Government spending
• A reduction in the amount the government sector
borrows each year (PSNCR)
These fiscal policies increase the rate of leakages from the
circular flow and reduce injections into the circular flow
of income and will reduce demand pull inflation at the
cost of slower growth and unemployment.
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MEASURES TO CONTROL INFLATION

3. DIRECT WAGE CONTROLS

If the policy of wages is effectively implemented, the real
income of wage and salary earners declines and thus in a
country where wages constitute an important part of the
national income, the consumption spending also falls
significantly.
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MEASURES TO CONTROL INFLATION

4. PRICE CONTROL
 It implies that the fixation of maximum prices at which
commodities is to be sold. Since the aim of the control
authorities is to make commodities available to the people
at prices which they can pay, the maximum prices for each
commodity is set below the market disequilibrium price.
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MEASURES TO CONTROL INFLATION

5. AN APPRECIATION OF THE EXCHANGE RATE

A rise in the value of the exchange rate might be achieved
by an increase in interest rates or through the purchase of
sterling via Central Bank intervention in the foreign
exchange markets.
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MEASURES TO CONTROL INFLATION

LONG-TERM POLICIES TO CONTROL INFLATION

 Labour market reforms
 Supply-side reforms: If a greater output can be
produced at a lower cost per unit, then the economy can
achieve sustained economic growth without inflation.
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THANK YOU