INFLATION

SARAVANAN S
 What is
Inflation ? Inflation :  Inflation is defined as a rise in the general price
level over a period of time.

 In other words, prices of many goods and

services such as housing apparel, food,
transportation, and fuel become dearer during
inflation.
Deflation :  Deflation is defined as fall in the general price
level over a period of time.

Both Inflation and Deflation create Problems…

What happens during Inflation : Value of Money goes down↓↓ and Prices rise High↑↑
Types of Inflation

 Creeping Inflation
 Walking or trotting Inflation
 Running Inflation
 Galloping Inflation
 Hyper Inflation
 Theories and Causes of Inflation

The main cause of inflation is the increase in the demand of goods

and services and at the same time decrease in the supply of goods
and services.

There are two theories related to the causes of inflation:

Demand-pull (when there is excess demand), and
Cost-push (when costs rise)
Theories and Causes of Inflation

Demand Pull Inflation –

This occurs when there is excess

aggregate demand in the economy
(overall) or in a specific market or
industry.
Businesses respond to high demand
by
raising prices to increase their profit
margin
Theories and Causes of Inflation

• Cost – push Inflation :

This occurs when costs of production or
operation are increasing.
• Cost Push inflation is mainly caused due to
the following factors:
· increase in wages.
· increase in cost of
raw materials
· increased cost of
imported components
(import-push inflation)
Growth vs. Inflation: India, 1951-2011
Average annual Average annual
growth rate of GDP at rate of
constant prices WPI inflation
Period (%) (%)
2005-06 to 2010-11 8.47 6.55
2000-01 to 2005-06 6.93 4.68
1995-96 to 2000-01 5.92 5.07
1990-95 to 1995-96 5.38 10.18
1980-81 to 1990-91 5.64 8.51
1970-71 to 1980-81 3.16 10.28
1960-61 to 1970-71 3.75 6.24
1950-51 to 1960-61 3.94 1.75

WPI - Wholesale Price Index

- measured weekly in India
The Indian evidence above shows the lack of any simple
unidirectional relationship between inflation and growth.
 Rate of Inflation

The relative price of food is computed

as the ratio of the WPI component for
primary food commodities to an index
of non-food manufacturing prices
computed from WPI data.
 Why is Inflation a Problem in India?
Price Effects :
Inflation makes some people worse off, but it makes others better off
Ex: 1. Increase in Gasoline prices affect the Truck drivers more but barely affects people
who go to there work by walk and economy vehicles
2. College tuition fees has risen almost twice as fast as average prices over the past
10 years, which hurts you a lot,
but may have little impact on a married couple with no children.
3. Poultry diseases causes a rise in the prices of Non-veg food items and affect people
who eats more of Non- veg
food items but it barely affects people eating Veg food.
4. People in Cities get affected more than people in small towns and villages
Income Effects :

Prices for goods and services mean income for some people. So, as some prices
increase faster
than other, some people’s income increase faster than others.
Ex: 1.Due to increase in number of automobiles working on Gasoline increased,
due to this most of the Oil companies
record very high amounts of improvements in profits every year
2. Due to ever increasing in pollution, the number of people suffering from
different diseases also increased which gave
chance to many pharmaceutical companies to improve profits every year
3. All the retail stores working on % profit’s increase there income when ever
there is increase in prices of goods
Wealth Effects :

1. Inflation redistributes income between Borrowers and Lenders

2. Inflation benefits the borrowers and hurts the lenders
Reason: As the value of money decreases at higher rate
 Inflation redistributes the social conditions of people

Causes of Inflation
Factors on Demand side : Factors on Supply Side :
1. Increase in Money Supply 1. Rise in administered prices
2. Increase in Disposable Income 2. Erratic agricultural growth
3. Deficit Financing 3. Agricultural price policy
4. Foreign exchange reserves 4. Inadequate industrial growth

Printing Of Money
is never a
Solution for Inflation
 Factors on Demand side
1. Increase in Money Supply
If the currency in circulation increased,
there would be a proportional increase
in the price of goods
3. Deficit Financing
government spends more money than it
receives as revenue, the difference being
made up by borrowing or minting new
funds, minting new funds decrease the
value of money and thus inflation
2. Increase in Disposable Income
Disposable income is total personal income
minus personal current taxes. disposable
income is the amount of "play money“ left to
spend or save. If this is increased people
spend money on unnecessary things and
there demand increases and thus inflation
4. Foreign Exchange Reserves
Foreign exchange reserves include
foreign currency deposits and bonds and
also adds gold reserves, which increase
the circulation of money and thus inflation
 Factors on Supply Side
1. Rise in administered prices
Prices decided by an individual producer
or seller not purely by market forces, this
is common when there is only one
supplier and he has chance to increase
the cost with out any conditions
3. Agricultural price policy
Due to fluctuating prices during mid 60’s
during the Pakistan war APP was
introduced to ensure stability in prices, so
when the supply decreases they have to
manage the prices in order to stabilize
the cost and inflation occurs
2. Erratic agricultural growth
India is country where in 60% of
people still relay on farming and
the weather is so uneven and
prices depend on the agricultural
productivity
4. Inadequate industrial growth
Most of the markets in India run foreign
imported products due to lack of
technology and other issues, so the
pieces also keep fluctuating on the other
countries markets and market value and
too much imports can lead to fall of
value of money
 Factors on Demand side
Increase in Printed Money Increase in Disposable Income

Due to Increase in disposable

money people spend money
lavishly independent of there
necessity and thus there is
increase in Inflation

Mainly seen in IT
Sector in India due to
its speedy growth

Deficit Financing Foreign Exchange Reserves

This happens every year Forex reserves increase every week

in India and India has a debt due to good participation of foreign
of 172 Billion Dollar up-to companies and latest reports from
now and still unable to repay RBI says 293 Billion Dollar
it to World bank investment from Foreign companies
 Factors on Supply Side
Rise in administered prices Erratic agricultural growth
Vegetable Max Min
Cost/kg Cost/kg
In case of India the administer can Tomato 60 5
be government or individual if it is
government then it is a fixed price if Potato 30 14
it is on the individual then there is Onion 70 20
lot more variations based on ones
Cauliflower 45 20
decision costs are decided
Brinjal 45 20
 Factors on Supply Side
Agricultural price policy

Though APP was successful for in some regions but due to poor
Infrastructure the food grains and vegetables stored always get
spoiled and due this the demand supply would decrease

Inadequate industrial growth

GDP growth
which clearly
depicts Industrial
Growth
They add inefficiencies in the market and make it difficult for companies to
budget or plan for long term

Uncertainty about the future purchasing power of money discourages

investments and savings

There can be negative impacts to trade from an increased instability in

currency exchange prices caused by unpredictable inflation

If the inflation rate in the economy of a country is higher than rates in

other economy’s there will be huge increase in imports and decrease
in exports (in terms of vaule) and hence huge fall in GDP

Higher income tax rate

Value of money decreases

 Measures to control Inflation
1. Effective policies to control inflation need to focus on the underlying causes of
inflation in the economy
Ex: 1. If the main cause is excess demand for goods and services, then
government policy should look to reduce the level of aggregate demand
2. If cost-push inflation is the root cause, production costs need to be
controlled for the problem to be reduced

Step to be taken
Investment in infrastructure and human capital to ensure that desired growth
does not exceed the productive capacity of the economy.

2. If Inflation is for short period of time and If not Food Inflation

Step to be taken
In the short-run the RBI should raise interest rates sharply to protect
its anti-inflationary credibility.
3. To eradicate Erratic agricultural growth problem
Step to be taken
Investment and promotion of organizational innovations in agriculture to ensure
that food supply does not become a bottleneck to growth and price to price (cost
effectively)

4. Demonetization Of Currency

Step to be taken
Primarily to curb unaccounted money. The higher denomination banknotes in
Rs.5000 and Rs.10000 were to reintroduced and these banknotes (Rs.5000 and
Rs.10000) were to be demonetized

5. A strong Fiscal Policy Reduction in unnecessary expenditure by the government

Step to be taken
Expenditures on public functions and rally's and public meeting, usage high
standards Infrastructure by public officials need to be decreased to certain
fixed level
 6. Check on the amount the government sector borrows each year

7. Moving towards greater independence for the central bank and transparency in
monetary policy to stabilise inflationary expectations. What
happens
8. Increase in Savings with fiscal
Policy
Policy recommended for short-run

Fiscal consolidation to ensure that fiscal policy does

not work at cross-purposes with monetary policy.

A loose fiscal policy, by increasing the debt burden

both directly and through its effect on interest rates,
would prove to be unsustainable in the long run
As the debt burden rises, the pressure to print
money to finance the fiscal deficit would rise,
thereby making it impossible to pursue an anti-
inflationary monetary policy.
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 of economy
Inflation is as violent as a mugger, as frightening as an armed robber and as deadly as
a hit man.
Ronald Reagan