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New Delhi Institute Of Management

Presentation by Group V Batch 13 (A)

Mohammad Salman
Ali Balister
Rajeev Vasudevan
Rakesh Aggarwal
Index
Introduction
Types of Inflation
Calculation
Causes
Effects of Inflation
Inflation and India (Impact on India)
Measures to Control Inflation
Inflation

Gross Domestic Product


Introduction
Inflation
• Inflation can be defined as the general tendency for
prices to rise and a decline in the purchasing power
of money.

• Inflation needs to be examined in REAL terms to


understand its actual impact upon the economy

• Example: If wages rise by 5% and inflation stands at


6% then in real terms wages have fallen by 1%.
Inflation Rate:

The Inflation rate is the percentage by which prices


of goods and services rise beyond their average
levels.
It is the rate by which the purchasing power of the
people in a particular geography has declined in a
specified period.
The rate of inflation may be calculated weekly, monthly
or annually.
However, it is always expressed as an annualized
figure.
Deflation
Deflation (for example, -1%) occurs when prices
actually decrease over a period of time. Please note
that deflation is not the same as disinflation, which is
when the rate of inflation decreases but stays positive
(for example, a change from a 3% rate to a 2% rate).

Stagflation –
is used when there is stagnation as well as inflation.
The economic cycle and the MPC’s role

GDP

Inflation rising GDP


Growth trend

Unemployment worries/inflation falling

Time
Types of Inflation
Moderate Inflation
Running Inflation
Galloping Inflation
Hyper Inflation
1. Moderate Inflation
It occurs when prices are rising slowly & when
the rate of inflation is less than 10 per cent
annually or it is a single digit inflation rate

When the price is moderate & is in the range


up to 2% it is called creeping inflation. And
when it is in the range of 4 to 5% it is called
as walking inflation.
2.Running Inflation
 When prices rise by more than 10 per cent a
year, running inflation occurs.

But, we may say that a double digit inflation


of 10-20 per cent per annum is a running
inflation.
3. Galloping Inflation
 According to Samuelson, when prices are
rising at double or triple digit rates of 20, 100
or 200 per cent a year, the situation is
described as ‘galloping’ inflation.

Galloping inflation is really a serious problem.


It causes economic disturbances.
4. Hyper Inflation
In hyperinflation prices rise every movement,
and there is no limit to the height to which
prices might rise. In quantitative terms, when
prices rise over 1000 per cent in a year, it is
called a hyperinflation.

In Germany, hyperinflation hit during the


1920s.
Here’s a German woman stuffing her fireplace
with worthless paper money in 1923.
CALCULATION OF INFLATION

Wholesale Price Index (WPI)


WPI was first published in 1902, and was one of the more
economic indicators available to policy makers until it was
replaced by most developed countries by the Consumer
Price Index in the 1970s.
WPI is the index that is used to measure the change in the
average price level of goods traded in wholesale market. In
India, a total of 435 commodities data on price level is
tracked through WPI which is an indicator of movement in
prices of commodities in all trade and transactions. It is
also the price index which is available on a weekly basis
with the shortest possible time lag only two weeks. The
Indian government has taken WPI as an indicator of the
rate of inflation in the economy.
How is it calculated?
If P0 is the current average price level and P −1 is
the price level a year ago, the rate of inflation
during the year might be measured as follows:

After the year the purchasing power of a unit of


money is multiplied by a factor 1 / ( 1 + inflation
rate ).
There are other ways of defining the inflation
rate, such as logP0 − logP −1 (using the natural
log), again stated as a percentage. In this case
after the year the purchasing power of a unit of
money is multiplied by a factor e −inflationrate .
There are two general methods for calculating inflation
rates - one is to use a base period, the other is to use
"chained" measurements. Chained measurements adjust not
only the prices, but the contents of the market basket
involved, with each price period. More common, however, is
the base period reference. This can be seen from inflation
reports from the "relative weight" assigned to each
component, and by looking at the technical notes to see what
each item in an inflation basket represents and how it is
calculated.
Consumer Price Index (CPI)
CPI is a statistical time-series measure of a
weighted average of prices of a specified set of
goods and services purchased by consumers. It is
a price index that tracks the prices of a specified
basket of consumer goods and services, providing
a measure of inflation.
CPI is a fixed quantity price index and considered by
some a cost of living index. Under CPI, an index is
scaled so that it is equal to 100 at a chosen point
in time, so that all other values of the index are a
percentage relative to this one.
World have changed form WPI to CPI as an
indicator of Inflation
India is the only major country that uses a wholesale
index to measure inflation. Most countries use the
CPI as a measure of inflation, as this actually
measures the increase in price that a consumer will
ultimately have to pay for.

CPI is official barometer of Inflation in:


USA, UK, Japan, France, Canada, Singapore,
China.
Why is India not switching over to the CPI
method of calculating inflation?
Finance ministry officials point out that there are many
intricate problems from shifting from WPI to CPI model.
Reluctant to change.
In India, there are four different types of CPI indices, and
that makes switching over to the Index from WPI fairly
'risky and unwieldy.' The four CPI series are: CPI
Industrial Workers; CPI Urban Non-Manual Employees; CPI
Agricultural labourers; and CPI Rural labour.
officials say the CPI cannot be used in India because
there is too much of a lag in reporting CPI numbers. In
fact, as of May 21, the latest CPI number reported is for
March 2006.
WPI is published on a weekly basis and the CPI, on a
monthly basis.
Causes of Inflation
DEMAND PULL INFLATION
COST - PUSH INFLATION

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DEMAND PULL INFLATION
Demand pull inflation occurs when aggregate
demand exceeds the aggregate supply
Demand pull inflation is commonly referred to too
much money chasing after too few goods and
services
Rise in aggregate demand which may due to a
rise in consumer demand or level of government
expenditure or investment by firm or country’s
exports or a combination of the four

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General price level
AS

P2

P1

P0 AD2
Increase in AD
An increase in above full
AD0 towards Yf
employment
(AD1 to AD2) (AD1
showto increase
AD2) increase
in AD1
price to P2level (P0 to P1)
the price

AD0

Real output has reached the maximum


0 limit but prices are still increasing
Yf Real output

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COST–PUSH INFLATION
Cost-push inflation refers to an increase in the
general price level associated with an
increase in the cost of production
Cost-push inflation basically means that
prices have been “pushed up” by increases in
costs of some of the factors of production
such as labor, capital etc.

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Effects of Inflation
Inflation can have negative and positive
effects on an economy.
Negative Effects:
Negative effects of inflation include: loss in
stability in the real value of money and other
monetary items over time; uncertainty about
future inflation may discourage investment and
saving, and high inflation may lead to shortages
of goods if consumers begin hoarding out of
concern that prices will increase in the future.

Positive Effects:
Positive effects include a mitigation of economic
recessions, and debt relief by reducing the real
level of debt.
NEGATIVE EFFECTS
1. Purchasing power
Inversely related to price
–price, dollar buys less
–(deflation, dollar buys more)
An increase in the general level of prices implies a
decrease in the purchasing power of the currency.
That is, when the general level of prices rises,
each monetary unit buys fewer goods and
services
2. Cost-push inflation
Rising inflation can prompt employees to demand
higher wages, to keep up with consumer prices.
Rising wages in turn can help fuel inflation. In the
case of collective bargaining, wages will be set as
a factor of price expectations, which will be higher
when inflation has an upward trend. This can
3. Interest rates rise in response to
inflation
 Discourages some borrowing and spending
 High inflation rates devalue savings
 Savings lose value if interest rate is less than
the inflation rate

4. Market Inefficiency
 High or unpredictable inflation rates they add
inefficiencies in the market, and make it difficult
for companies to budget or plan long-term.
 Inflation can act as a drag on productivity as
companies are forced to shift resources away
from products and services in order to focus on
profit and losses from currency inflation
 A change in the supply or demand for a good
will normally cause its price to change,
signaling to buyers and sellers that they should
re-allocate resources in response to the new
market conditions.
 Investors are scared to invest for long-term
purposes hence the short-term investments
increase.
Positive Effects
1. Labor-market adjustments
 This can lead to prolonged disequilibrium and
high unemployment in the labor market.
 Inflation would lower the real wage if nominal
wages are kept constant.
 As it would allow labor markets to reach
equilibrium faster.

2. Debt Relief
 Debtors who have debts with a fixed nominal
rate of interest will see a reduction in the "real"
interest rate as the inflation rate rises.
• Banks and other lenders adjust for this inflation risk either
by including an inflation premium in the costs of lending
the money by creating a higher initial stated interest rate
or by setting the interest at a variable rate.

3. Room to maneuver
The primary tools for controlling the money
supply are the ability to set the discount rate, the
rate at which banks can borrow from the central
bank.
open market operations which are the central
bank's interventions into the bonds market with
the aim of affecting the nominal interest rate.
Inflation & India
Impact of Inflation in India
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Wholesale Price Inflation

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Inflation & India
Indian inflation is measured by Wholesale
Price Index (WPI) is released every week. Past
One month this number came out negative for
the first time in 32 years.
Although WPI is indicating deflation, no one in
India is concerned about it and this negative
number is attributed to high base index.
The Economic Effects of Inflation

Inflation & Distribution of Income


The effect of inflation on income distribution
depends on how it affects the prices received
and price paid. (Price received can be called as
income whereas price paid is called as
expenditure).
Inflation changes income & distribution pattern
only when it creates divergence between total
price received and paid.
Effect of Inflation on Distribution of
Wealth
Asset

Price Variable Assets Fixed Claim Assets


(Bonds, Loans & Term Deposit)

Physical Assets Financial Assets


(Building, Land) (Share & Stocks)

The effects of Inflation on Distribution of wealth depend on how inflation affects


the net worth (Assets – Liabilities)
Effect of inflation on Different
sections of society
Wage Earners:
Wage earners in general are losers during
period of inflation.
The wage earners are labour so it is divided into
organized and unorganized sector. Organized
labour Market gets the compensation through
union but unorganized labour Market doesn’t
get the increment in wages as compared with
organized sector at time of inflation.
Effect of inflation on Different
sections of society Cont….
Producers:
Producers lose or gain depends on price they
pay and receives during the period of inflation.
The product price rises due to demand pull
factors & rise in money supply but the input
price remain the same and because of this
profit margin increases.
The producers gain during inflation due to
wage-lag & input increases at lower rate.
Effect of inflation on Different
sections of society Cont….
Fixed Income Class:
 Fixed income class groups are the losers during the
time of inflation.
 The reason is income is fixed but the prices of
goods, commodities & services increases.
Borrower & Lenders
 In this case Borrower gains and lender losses.
 For example a borrower take a home loan at percent
say 12% on Rs. 5,00,000/- for five years at simple
interest . After 5 yrs the rate of property gets
double. So after five yrs borrower will pay Rs.
8,00,000/- but the value of his property is Rs.
10,00,000/-.
Effect of inflation on Different
sections of society Cont….
The Government:
Government is the net gainer during period of
inflation. Government collects tax inform of
direct (Personal & corporate Taxes) and indirect
tax (Custom Tax, Excise Tax & Sales Tax).
 Direct Tax:
 Inflation increases the nominal income at the rate of

inflation, real income remaining the same.


 As a consequence an income which was non-taxable

prior to inflation becomes taxable after inflation.


 This lead to tax revenue. Because of this income

taxable at course becomes taxable at higher rate


Effect of inflation on Different
sections of society Cont….
 Indirect Tax:
 Indirect tax contributes major part of income for

government.
 As prices are higher at time of inflation the revenue

generated is high.
 So, we can make out that government is net

borrower and enjoys net gain during period of


inflation.
Effects of Inflation on Economic
Growth

Theoretical Level Empirical Level


(Practical Level)
The rate of Economic Until the 1970 high
growth depends primary inflation usually took a
on the rate of capital hand to hand with high
formation which depends employment & Output.
on rate of saving & At time of inflation
Investment. investment are high &
Lower rate of income job are plentiful.
increases investment. Output & inflation have
temporary positive
relationship.
Effects of Inflation on Employment
Inflation when allowed to grow

INFLATION

EMPLOYMENT

ECONOMIC GROWTH
Effects of Inflation on Employment
Inflation when not allowed to grow

INFLATION

EMPLOYMENT

ECONOMIC GROWTH
Effects of Inflation on Common
People
Goods Once Essential, now luxurious

Real Market Scenario


A). Monetary measures: Monetary measures relate to the control in the supply
and circulation of money in the country.

1. Bank rate :
In case of inflation, the bank rate is increased; the supply of money is
controlled.

2.Open market operation:


During inflation, the central bank sells govt. securities and price bonds in the
open market in order to contract the supply of money.

3. Variable reserve ratio:


In order to control inflation, the central bank increases the reservation.

4. Credit Rationing:
When there is inflationary pressure, the State bank adopts the policy of credit
rationing.
5. CRR (Cash Reserve Ratio):
Cash Reserve ratio is amount of cash that a Bank has to kept with RBI.

6. SLR (Statutory Liquid Ration):


SLR is a percent of cash which a Bank has to kept with themselves as a
reserve.
B). Fiscal Measures: Measures in connection with public borrowing public
expenditures and public revenues are called fiscal measures.

1. Public Borrowing: During inflation, increase the public borrowing,


during deflation, decrease in public borrowing.

2. Public Revenues: In order to control inflation, the increase in public


revenues by the Govt.

3. Public expenditures: Inflation is also controlled by decreasing the


public expenditures by the Govt.
(C). Realistic Measures:
1. Increase the supply of goods and services: When the supply of goods
and services is increased, the prices will come down.

2. Population planning: Control on population by adopting different measures


of family planning will reduce the demand and finally prices will be controlled.

3. Price control policy: The govt. should adopt strict price control policy
against the profiteers and hoarders.

4. Economic Planning: Effective economic planning is necessary to control


the inflation in the country.
The central banks, monetary authorities or finance ministries of most nations
have the authority to take economic measures to control rising inflation by
regulating the following factors:

 Reducing the central bank interest rates and increasing bank interest rates.

 Regulating fixed exchange rates of the domestic currency.

 Controlling prices and wages.

 Providing cost of living allowance to citizens in order to create demand in the


market.
Inflation cannot be controlled by taking a single measure. However, if
monetary and fiscal measures are wisely coordinated, it can greatly help in controlling
the continuous process of rising prices. The main anti inflationary measures both short
and long terms are: Containing money supply; the monetary supply should be kept within
reasonable limits.

 Reducing budgetary deficit :

the budgetary deficit should be kept low level. The deficit should be met by disciplined
policy of demand management. Emphasis on commodity producing sectors:The
government should give special attention to the production of cottons, wheat, vegetable ,
edible oil etc. it will have soothing effects on inflating.
Commodity balance:

The government should have a strict watch on the prices of essential


commodities in the country. It should take immediate steps in changing the
import and export duties and maintain the availability of goods is reasonable
prices.
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