SHOULD THE CENTRAL

BANK AIM FOR 0

INFLATION
Introduction of Topic
 What is Inflation ?
● Sustained increase in general level of prices for goods & services
● As inflation rises, every unit of medium of exchange (dollar/rupee) one
owns, buys a smaller percentage of good or service.
● Thus purchasing power goes down which results in fall in the value of
money.
EFFECTS OF INFLATION
Erodes Purchasing Power

Encourages Spending,
Investing

Causes More Inflation

Reduces Unemployment

Increases Growth
 Role of Central Bank
● An institution designed to oversee the banking system and regulate quantity
of money in economy.
● The Reserve Bank of India (RBI) is the central bank of India.
● Manages a state’s currency, money supply, interest rates.
● Prints the national currency which usually serves as the nation’s legal tender.
● Operates primarily for service and not for profit.
MEASURES FOR CONTROLLING
INFLATION
Monetary
Measures

Price Fiscal
Control Measures
What is Zero Inflation ?
● Zero Inflation is a state when the economy reaches a state when there is no
inflation.
● From a state of inflation when an economy progresses towards lowering the
rate of inflation it endeavors to reach a point when there is no inflation at all
and therefore the situation of zero inflation is achieved.
● It is a big achievement for every economy because in the present day it is not
at all easy to establish a zero inflation economy.
 PROS OF ZERO INFLATION
● The zero inflation economy enables to lessen the price distortion, it also reduces the uncertainty
involved in price drift.
● The zero inflation also aids in enhancing the economic growth along with adding liquid money to the
economy. The benefits of zero inflation are far reaching.
● The best example is US. It had faced a high inflation during the 1970s but after a long effort they
could establish an economy that was clear off inflation. They reached a stage of zero inflation.
● In such an environment the corporation is in a better position to plan for the economy and implement
new rules, policies for the betterment of the economy. The government can cope better with the
problems as they do not have to face the sudden shocks of supply.
● There is an accumulation of long-term investments as the investors are willing to invest money for a
long time without any risk.
● With the inflation being controlled the RBI can also shoulder its responsibilities more easily. It is easy
for them to allow expansions since they can avoid the boom bust cycles that lead to recessions.
● This essentially means that the RBI can reduce the rates which would help the Asian Countries. All
these measures would consequently produce good results for the economy. The best part would be
that the productivity level would increase and the capital accumulation would be very high
 CONS OF ZERO INFLATION
● Rising real value of debt. With low inflation, it becomes harder than expected for people to pay back
their debts – they have to spend a higher % of income on debt repayments leaving less income for
other spending. Which is not good for a country like India as Indians have very low per capita
income.
● Rising real interest rates. The fall in inflation increases real interest rates, whether we like it or not.
Rising real interest rates make it less attractive to borrow and invest; it encourages consumers to
save. If the economy is depressed, this rise in real interest rates can make monetary policy less
effective in encouraging growth.
● Delay purchasing. Falling prices can encourage people to delay buying expensive luxury goods –
they feel they need to wait a year because prices will be lower.
● Low inflation is an indication of low growth. A normal period of economic growth would typically
give a moderate rate of inflation (2%). If inflation has fallen to 0%, it suggests that there is intense
price pressure to encourage spending and the recovery is very fragile.
Costs of Zero Inflation
● Sacrifice ratio: reducing inflation by 1% leads to 5% lower annual output. If
inflation was at 4% and we were to reduce it to 0%, it would mean giving up
20% of annual output.
● Most people are risk averse, so the cost of giving up this much output
outweighs the benefit of having zero inflation.
● A permanent reduction in GDP and employment of 1-3%
● Sticky-wage contracts - it would reduce output and increase unemployment
through rigidity in contracts specified in money amounts. 
Advantages of Low inflation over Zero Inflation
● Rewrite tax laws to take into account the effect of inflation
● Reduce cost of redistribution of income: Lenders should account for
inflation in their contracts
● Zero inflation increases risk for deflation which causes wages to fall and less
goods produced which lead to unemployment and low inflation provides a
safety barrier against this
● At low levels of inflation, real interest rate is normally still positive.
Therefore Inflation provides a savings and investment incentive.
 Reasons
• Creates Confusion And Inconvenience.

• Income Inequality

• Unemployment - people and businesses may be less willing to make investments

and spend on consumption, and this lower demand keeps them from bidding up
prices.

• Problems Associated With Deflation

• Negative Economic Growth

• Zero inflation could make real interest rates higher than desirable.
 Main Aim of Central Bank:

● Some economists feel that a central bank should adopt as primary policy
reducing inflation at least next to zero.
● Few suggest that Parliament should enact a law that keeping prices low
should be mandatory.
● Those who say that a central bank should aim at reducing inflation to
zero or near zero point out that the costs of disinflation are temporary,
while the benefits are more permanent.
● Those deposed to zero inflation policy feel that moderate inflation plus
lower unemployment is better than zero inflation with high
unemployment. Unemployed people suffer social and income trauma.
Case Study
ZERO INFLATION IN THE UNITED
KINGDOM
• Occurred in the year 2015.
• Inflation as measured by the CPI fell due to a smaller rise in clothing prices.
• There was also a sharp fall in the oil prices and faced a continuing supermarket price
war.
• The rate of core inflation - which strips out the impact of changes in the price of
energy, food, alcohol and tobacco - fell to 1.0% in august from the previous rate of
1.2%.
• Bank policymakers voted 8-1 to hold rates again, and said the risks from the slowing
Chinese economy had increased since august.
• The bank of England's key interest rate has been at the record low of 0.5% since march
2009, and despite much speculation about when it might rise, inflation still remains
well below the bank's target of 2%.
GOAL: To Maintain a Low Level of Inflation
● A two percent level of inflation over time is a risk-averse number.
● By maintaining some inflation, deflation can be avoided during an economic
downturn.
● The FOMC (U.S.) judges that inflation at the rate of 2 percent is most consistent
over the longer run with the Federal reserve’s mandate for price stability and
maximum employment.
● Having at least a small level of inflation makes it less likely that the economy
will experience harmful deflation if economic conditions weaken.
● Therefore, The FOMC implements monetary policy to help maintain an inflation
rate of 2 percent over the medium term.
 CONCLUSION
● Zero inflation would have both costs and benefits, but the costs likely would
not be small, and the benefits likely would be smaller; they might even be
negative
● Instead of trying to manipulate the inflation rate, policymakers should
seriously consider allowing all demand deposits to earn market interest rates,
paying interest on reserves held by financial institutions as backing for these
and other deposits, lowering the tax rate on capital income, and indexing the
federal tax code to inflation. These changes could achieve most of the
desired benefits of zero inflation without the possibly significant costs.