EFFECTS OF INFLATION &

CONTROL OF INFLATION

MEBE 2021-22
 EFFECT OF INFLATION ON INCOME
DISTRIBUTION

Gainers from increased incomes

 Profits rises faster than all other income sources in an inflation
 Manufacturers, farmers and traders (profit earners) benefit from rising prices
 Unionised labour in large scale manufacturing companies with strong
bargaining power see wage increases
 Investors in equities benefit as higher profits allow shareholders to earn
higher dividends. Share prices also rise
 Debtors benefit as the value of money borrowed falls
 EFFECT OF INFLATION ON INCOME
DISTRIBUTION
Incomes like wages, salaries, rent & interest rates do not rise as fast as commodity
prices
Losing out due to a fall in real value of income earned
 Fixed income earners (salaried employees)
 Non-unionised labour in small scale and unorganised sectors without bargaining
power
 Investors in fixed income earning bonds
 Rent earners without escalation clauses in rent agreement
 Creditors who find that the real worth of interest and principal amount erodes
 EFFECT ON EMPLOYMENT & OUTPUT

A mild inflation encourages production if the economy is working at less than

full employment level
 An increase in price increases profits, encouraging producers to expand
employment and output
 There is reallocation of resources to those industries where price has risen
 Industries where there is no price rise could see contraction in output
 Uncontrolled rise in price will have disastrous effects as cost increases leads
to delays in project completion
 EFFECT ON LONG RUN GROWTH

 Huge profit margins provides firms with the resources to invest in capital
goods
 Higher savings among the rich provides funds for capital accumulation
 Shift of resources from wage goods (comprising mainly of essential consumer
goods) to capital goods
 This can lead to increases in productive capacity in an economy and long run
growth
However, if input costs like wages, interest, steel, cement, etc rises, cost of
investment projects rises leading to delays in completion
 CONTROL OF INFLATION

Restrictive Monetary Policy

 Increased repo rate, CRR, bank rate, open market operations (OMO) by the Central
Bank of the country. This increases the cost of borrowing and discourages investment
spending
Restrictive Fiscal Methods
 An increases in tax rates reduces disposable income and reduces spending
 A decrease in government expenditure reduces aggregate demand
A restrictive monetary and fiscal policy is advised only in the case of a demand induced
inflation
A restrictive policy is not appropriate in supply side inflation as it creates further supply
shortages and price rise
 CONTROL OF INFLATION

Direct control on price

 Fixing legal ceiling on price
 Rationing of scarce goods so that it can be distributed to larger number of people. Usually
done during war when there are severe supply shortages
Restriction of exports of essential goods and reducing import controls
Indexation
 Indexation is a method where there is automatic adjustment of wages and other incomes
to inflation rate
 It does not control an inflation but makes inflation more bearable
 Useful in cases of long term loan contract (25-30 years). Indexed debts are where interest
payments are adjusted upwards to account for inflation
 WHOLESALE PRICE INDEX & CONSUMER PRICE
INDEX

WPI & CPI are two crucial metrics that define the price of
goods and services in an economy

CPI
 Measures change in the retail price of goods
& services
 Includes both goods & services
 Categories included – food & beverages,
clothing, housing, fuel, light, transport,
education, health, recreation, etc.
 CPI is released on a monthly basis
 Is of importance to the general public as it
helps measure cost of living index
WPI
 Measures change in the price of goods in
the wholesale market
 WPI is released on a weekly basis
 Goods alone are included, not services
 Includes primary articles, fuel and power
and manufactured goods
 Is of importance to those who keep track of
wholesale prices
 INFLATION TARGETING IN INDIA

 India had adopted flexible inflation framework in 2016 and the target was to be
applicable till March 2021
 The Monetary Policy Committee (MPC) would be entrusted with the task of fixing
benchmark policy rate (repo rate) to keep inflation rates within the target
 RBI’s inflation target (CPI) was set at 4% with a tolerance band of +/− 2%
 The lower tolerance band should not be less than 2% and the upper tolerance
band should not exceed 6%
 Consumer inflation outside this range for 3 consecutive quarters would constitute
monetary policy failure
 INFLATION TARGETING IN INDIA – AN
EVALUATION

 The policy has done well to reduce inflation and improve transparency in the
period 2016 -2019
 The average inflation rate measured through GDP deflator declined in the
targeting period
 The average inflation which was 5.69% for the 5 years in the pre-targeting period
was 3.47% in the last 5 years
 There was a fall in average inflation volatility in this period. Stable inflation rates
allows for favourable investment decisions and help growth
 RBI has decided to retain the inflation target of 4% with the same upper and
lower bounds (+/− 2%) from April 1, 2021 to March 31, 2026