NAME-GAURAV VYATYANI

FYBAF

ROLL NO-HFBAF275

SUBJECT :- ECONOMICS

TOPIC :- MENTION THE PERIODS WHEN

INDIA HAS FACED THE PROBLEM OF
INFLATION AND FIND OUT THE CAUSES
ASSOCIATED WITH THE INFLATION . ALSO
DISCUSS THE ROLE OF MONETARY POLICY
TO CONTROL INFLATION.
Introduction
Inflation happens when the price of goods and services increase, while deflation takes place
when the price of the goods and services decrease in the country. Inflation and deflation are the
opposite sides of the same coin.
Maintaining the balance between these two economic conditions, i.e. inflation and deflation is
essential as the economy can quickly swing from one condition to the other as a result of these
two conditions. The Reserve Bank of India keeps an eye on the levels of price changes and
controls deflation or inflation by conducting monetary policy, such as setting interest rates in
India.
Inflation
Inflation is the rate at which the prices for goods and services increase. Inflation often affects the
buying capacity of consumers. Most Central banks try to limit inflation in order to keep their
respective economies functioning efficiently. There are certain advantages as well as
disadvantages to inflation.
Inflation refers to the increase in the prices of the goods and services of daily use, such as food,
housing, clothing, transport, recreation, consumer staples, etc. Inflation is measured by taking
into consideration the average price change in a basket of commodities and services over a
period of time. Inflation is calculated in India by the Ministry of Statistics and Programme
Implementation.
A simple example would be, suppose a kg of apple cost Rs.100 in 2019 and it cost Rs.110 in
2020, then there would be a 10% increase in the cost of a kg of apple. In the same way, many
commodities and services whose prices have raised over time are put in a group and the
percentage is calculated by keeping a year as the base year. The percentage of increase in prices
of the group of commodities is the rate of inflation.
Causes of Inflation
Inflation is caused by multiple factors, here are a few:
Money Supply
Excess currency (money) supply in an economy is one of the primary cause of inflation. This
happens when the money supply/circulation in a nation grows above the economic growth,
therefore reducing the value of the currency.
In the modern era, countries have shifted from the traditional methods of valuing money with the
amount of gold they possessed. Modern methods of money valuation are determined by the
amount of currency that is in circulation which is then followed by the public’s perception of the
value of that currency.
National Debt
There are a number of factors that influence national debt, which include the nations borrowing
and spending. In a situation where a country’s debt increases, the respective country is left with
two options:
Taxes can be raised internally.

Additional money can be printed to pay off the debt.

Demand-Pull Effect
The demand-pull effect states that in a growing economy as wages increase within an economy,
people will have more money to spend on goods and services. The increase in demand for goods
and services will result in companies raising prices that the consumers will bear in order to
balance supply and demand.
Cost-Push Effect

This theory states that when companies face increased input cost on raw materials and wages for
manufacturing consumer goods, they will preserve their profitability by passing the increased
production cost to the end consumer in the form of increased prices.
Exchange Rates
An economy with exposure to foreign markets mostly functions on the basis of the dollar value.
In a trading global economy, exchange rates play an important factor in determining the rate of
inflation.
Effects of Inflation
When there is inflation in the country, the purchasing power of the people decreases as the prices
of commodities and services are high. The value of currency unit decreases which impacts the
cost of living in the country. When the rate of inflation is high, the cost of living also increases,
which leads to a deceleration in economic growth. However, a healthy inflation rate (2-3%) is
considered positive because it directly results in increasing wages and corporate profitability and
maintains capital flowing in a growing economy.
Steps to offset Inflation and its effects on Your Retirement
Factoring for inflation is an essential process for financial planning. The question is how much
will you actually need when you retire? Here are a few ways you can retire financially sound
keeping inflation in mind.
Invest in long-term investments.

When it comes to long-term investments, spending money now for investments can allow you to
benefit from inflation in the future.
Save More
Retirement requires more money than one might imagine. The two ways to meet retirement goals
are to save more or invest aggressively.
Make balanced investments

Though investing in bonds alone feel safer, invest in multiple portfolios. Do not put all your eggs
in one basket to outpace inflation.
Deflation
Deflation is generally the decline in the prices for goods and services that occur when the rate of
inflation falls below 0%. Deflation will take place naturally, if and when the money supply of an
economy is limited. Deflation in an economy indicates deteriorating conditions.
Deflation is normally linked with significant unemployment and low productivity levels of goods
and services. The term “Deflation” is often mistaken with “disinflation.” While deflation refers
to a decrease in the prices of goods and services in an economy, disinflation is when inflation
increases at a slower rate.
Causes of Deflation

Deflation can be caused by multiple factors:

Structural changes in capital markets
When different companies selling similar goods or services compete, there is a tendency to lower
prices to have an edge over the competition.
Increased productivity
Innovation and technology enable increased production efficiency which leads to lower prices of
goods and services. Some innovations affect the productivity of certain industries and impact the
entire economy.
Decrease in the supply of currency
The decrease in the supply of currency will decrease the prices of goods and services to make
them affordable to people.
Effects of Deflation

Deflation may have the following impacts on an economy:

Reduction in Business Revenues
In an economy faced with deflation, businesses must drastically reduce the prices of their
products or services to stay profitable. As reductions in prices take place, revenues begin to drop.
Lowered Wages and Layoffs

When revenues begin to drop, businesses need to find means to reduce their expenses to meet
objectives. One way is by reducing wages and cutting jobs. This adversely affects the economy
as consumers would now have less to spend.

Frequently Asked Questions

How to measure Inflation?

There are two ways to measure inflation, i.e. Wholesale Price Index (WPI) and Consumer Price
Index (CPI). The WPI is a measure of the average change in prices of goods in the wholesale
market or wholesale level. The CPI is the measure of change in the retail price of goods and
services consumed by a population of an area in a base year.
How does the Reserve Bank of India (RBI) control inflation and deflation?
One of the RBI’s key responsibilities is to keep inflation in check. The RBI keeps inflation in
check by tweaking the interest rates. The RBI aims to make loans costlier by increasing the
lending rates and thus discouraging borrowing which in turn, discourages spending. As people
spend less money, prices stop rising and inflation moderates. In contrast, deflation gives the RBI
room for cutting interest rates.
Is inflation considered good for the economy of the country?
Inflation is viewed as positive when it helps boost consumption and consumer demand, driving
economic growth. Some believe inflation is meant to keep deflation in check, while others think
inflation is a drag on the economy. When the economy is not running at capacity, i.e., there is
unused labour or resources, inflation theoretically helps increase production. It also makes it
easier for debtors, who can repay their loans with money that is less valuable than the money
they borrowed.
What is the effect of deflation on the economy of the country?
Just like inflation, deflation can be a continuous cycle. When prices continue to fall over time,
consumers can withhold spending money in the long term which means demands continue to
fall, leading to further deflation. A fall in sales is not good for company profits. As a result,
companies too withhold investing in new projects. All this leads to a slowdown in the economy.
Countries often struggle to get out of the deflation cycle.
Who is benefited most by inflation?
Inflation will benefit those people with large debts who can easily pay back their debts when
prices rise up. It will hurt those who keep cash savings and workers with fixed wages. 
Who will benefit from deflation?
Consumers will benefit from deflation in the short term as the prices of goods will reduce. When
the prices of goods reduce it increases the purchasing power of the consumers and also helps the
consumers to save more.
How Do Governments Fight Inflation?
PETE RATHBURN
Inflation occurs when spending on goods and services outstrips production. Prices can rise
because of supply constraints that increase the cost of producing goods and offering services, or
because consumers, enjoying the benefits of a booming economy, spend their excess cash faster
than producers can increase production. Inflation is often the result of some combination of
these two scenarios.
Governments generally try to keep inflation within an optimal range that promotes growth
without dramatically reducing the purchasing power of the currency. In the U.S., much of the
responsibility for controlling inflation falls on the Federal Open Market Committee (FOMC), a
Federal Reserve committee that sets monetary policy to achieve the Fed's goals of stable prices
and maximum employment.1  
There are many methods used to control inflation and, while none are sure bets, some have been
more effective and inflicted less collateral damage than others.
KEY TAKEAWAYS

 Governments can use wage and price controls to fight inflation.

 These policies faired poorly in the past, leading governments to look elsewhere to
control the economy.
 Governments may pursue a contractionary monetary policy, reducing the money supply
within an economy.
 The U.S. Federal Reserve implements contractionary monetary policy through higher
interest rates and open market operations.
 The Fed used reserve requirements to manage the nation's money supply but dropped
these limits until further notice.

How Can the Government Control Inflation?

Price Controls
Price controls are price caps or floors mandated by the government and applied to specific
goods. Wage controls can be implemented in tandem with price controls to suppress wage push
inflation.
In 1971, U.S. President Richard Nixon implemented far-reaching price controls in an attempt to
counter rising inflation. The price controls, though initially popular and considered effective,
could not control prices when in 1973 inflation skyrocketed to its highest levels since World
War II.
Despite a number of intervening factors (e.g., the end of the Bretton Woods System, poor
harvests, the Arab oil embargo, and the complexity of the 1970s price control system), most
economists view the 1970s as evidence enough that price controls are an ineffective tool for
managing inflation.234

Contractionary Monetary Policy
Contractionary monetary policy is now a more popular method of controlling inflation. The goal
of a contractionary policy is to reduce the money supply within an economy by
increasing interest rates.5 This helps slow economic growth by making credit more expensive,
which reduces consumer and business spending.
Higher interest rates on government securities also slow growth by incentivizing banks and
investors to buy Treasuries, which guarantee a set rate of return, instead of the riskier equity
investments that benefit from low rates.
Below are some of the tools through which the U.S. central bank, the Federal Reserve, fights
inflation

Federal Funds Rate

The federal funds rate is the rate at which banks lend each other money overnight. The fed
funds rate is not directly set by the Federal Reserve. Instead, the FOMC declares an ideal range
for the fed funds rate and then adjusts two other interest rates—interest on reserves (IOR) and
the overnight reverse repurchase agreement (ON RRP) rate—to push interbank rates into the
ideal fed funds range.6
IOR is the rate banks earn on their deposits with the Federal Reserve.7 Since the U.S. has never
defaulted on its debt, IOR is considered a risk-free rate and, thus, the lowest interest rate any
reasonable lender should accept.
The ON RRP rate functions similarly. It exists because not all financial institutions have
deposits with the Federal Reserve. The ON RRP entitles those institutions to essentially
purchase a federal security at night and resell it to the Fed the next day. The ON RRP rate is the
difference between the price at which the security is bought and sold.8
By raising these rates, the Federal Reserve encourages banks and other lenders to raise rates on
riskier loans and siphon more of their money to the no-risk Federal Reserve, thereby reducing
the money supply, which has the effect of reducing inflation.

Open Market Operations

Reverse repurchase agreements are an example of open market operations (OMOs), which
refers to the buying and selling of Treasury securities. OMOs are a tool with which the Federal
Reserve increases (by buying Treasuries) or decreases (by selling Treasuries) the money supply
and adjusts interest rates.
The infamous Federal Reserve balance sheet grows when the Fed buys securities and shrinks
when it sells them. Buying securities promotes liquidity in financial markets and puts downward
pressure on interest rates while selling securities does the opposite.10
Reserve Requirements
Up until March 26, 2020, the Federal Reserve also managed the money supply through  reserve
requirements, or the amount of money banks were legally required to keep on hand to cover
withdrawals. The more money banks were required to hold back, the less they had to lend to
consumers.Though reserve requirements were dropped to zero in March 2020, the Fed retains
the authority to restore reserve requirements in the future.12

Discount Rate
The discount rate is the interest rate charged on loans made by the Federal Reserve to
commercial banks and other financial institutions. The lending facility through which these
short-term loans are made is called the discount window. The discount rate, which is the same
across all Reserve Banks, is set by consensus of each regional bank's board of directors and the
Fed's Board of Governors.13
Though the discount window's primary purpose is to fulfill banks' short-term liquidity needs and
maintain stability in the banking system, the discount rate is yet another interest rate that needs
to be raised to temper inflation.

The Bottom Line

Governments have relatively few ways to stop inflation. They can put a cap on prices, but the
broad price controls required to impact inflation don't have a great track record. Pursuing a
contractionary monetary policy is the preferred method of controlling inflation today, but so-
called soft landings are hard to pull off.