INFLATION

Introduction
 Inflation generally means increase in the price of goods
and services.

 It is the process of persistent and substantial rise in

general level of prices even after full employment level of
output.

 As inflation rises, the value of currency goes down.

Thus, the purchasing power of the currency, i.e. the
goods and services that can be bought in a unit of
currency too goes down. So, Inflation is the stage of too
much money chasing too few goods.
 India and Inflation
 Inflation is not stranger to the India economy. In fact, till
the early nineties Indians were used to double – digit
inflation.

 But since the mid – nineties controlling inflation has

become a priority for policy makers.

 While inflation till the early nineties was primarily caused

by domestic factors. Today the situation has changed
significantly.

 Inflation today is caused more by global factors rather

than domestic factors.
 India had virtually no inflation during 1950s.
It had a moderate rate of inflation during (6.1% p.a)
during 1960s.
In 1970s, however, the rate of inflation had almost
reached a double – digit rate (9.9% p.a).
During 1990 – 91 : 10.6%
2001 – 2006 : 4.7%
April 2007 : 6.5%
 How India calculates Inflation?
 India uses the Wholesale Price Index to calculate and
then decides the rate of inflation in the economy.

 Wholesale Price Index (WPI) – 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.
WPI which is an indicator of movement in prices of
commodities in all trade and transactions.
 Types of Inflation
Main Types of Inflation

 Creeping inflation
very low rate.
2-3% increase in prices.
Beneficial for the economy.

 Walking inflation
3-7% rise in prices.
Below 10%.
 Running inflation

Rapid increase in prices in a very short period.

10-20%
Adverse effect on middle and poor classes.
It discourages savings.

 Hyper inflation
When prices rise at an unexpected rate.
When running inflation is not controlled.
It was witnessed in Germany after 1932 and which made
the people lose all confidence in German currency. It completely
wiped away fixed income groups and poor classes of the society.
Some other types of inflation
 Open inflation
When prices are allowed to rise without
any attempt on the part of the govt to control them.
Prices continue to rise according to
demand and supply conditions.

 Suppressed inflation
Rising prices are checked by
administrative measures like rationing, price control, etc.
by the govt.
 Theories or causes of Inflation
 Demand pull inflation theory
 Cost push inflation theory

Demand Pull Inflation Theory

Oldest theory of price-rise.
When AD > AS
Arises due to excessive demand.
 Causes of Demand Pull Inflation
1.Mounting Govt. Expenditure:

Year Expenditure (Rs. Crores)

1950-51 740
1980-81 37,000
2004-05 9,02,300

The annual average rate of investment by the

government under ‘five year plans’ has risen from
Es. 1,000 crores in the 1950’s to Rs. 30, 000 crores
in the 1980’s and to over Rs. 80, 000 crores during
the 1990’s and Rs. 3,08,550 during the 10th five
year plan (2002-07)
2. Increase In Money Supply

Year Money supply

with public
1970-71 7,340

1980-81 23,120

1990-91 92,890

2005-06 8,25,260
3. Role of Black Money
 It is well known that there is huge accumulation of
unaccounted money in the hands of tax evaders,
smugglers, builders and corrupt politicians and
government servants.

 The black-money was estimated to be Rs.

6,00,000 crores in 1997-98 and nearly
25,00,000 crores in 2006-07

4. Growth of Population
 “Increase in population by 18-19 million
every year –it used to be 14-15 million two
decades ago”.
 Cost Push Inflation Theory
 New theory of production.
 Caused by increase in cost of production.
 Rise in prices on the one hand and fall in
output and employment on the other hand.
 Increase in the overall price level due to
cost pressure is known as cost push or
supply side inflation.
 Causes of Cost Push Inflation
 High wage rates
 Higher profit margins
 Higher taxes
 Higher prices of inputs
 Fluctuations in Output and Supply

Ex: Food Grains Production (in tonnes)

Year Production
1964-65 89 million
1965-66 72 million (fall 17 million)
2001-02 212 million (peak)
2002-03 174 million (decline of 38 million)
 Effects of Inflation
A high rate of inflation is described as ‘Enemy no one’. It makes the
life of poor miserable.

 Effect on production

 Effect on distribution of income

Producers or entrepreneurs
Debtors and creditors
Holders of fixed interest security and shareholders
Effect on fixed salaried class

 Other effects
Reduction in savings
Unfavorable BOP
Depreciation of exchange rate
Effect on empt
Effect on taxes
 Measures to Control Inflation
Monetary Measures:

 Quantitative measures
a) Bank rate
b) Open market operations
c) Change in Statutory Liquidity Ratio (SLR)
d) Change in minimum reserve ratio (CRR)

 Qualitative or selective measures

a) Higher marginal requirement
b) Rationing of credit
c) Moral pressure
d) Direct action
 Fiscal Measures:
 Reduction in unnecessary Govt expenditure
 Increase in taxes
 Increase in savings
 Public debt