Policies To Combat Inflation
Submitted to: -
Dr. Sanjay Kumar Submitted By: -
Section: - F12
In economics, inflation or price inflation is a rise in the general level of prices of goods
and services in an economy over a period of time.The term quot;inflationquot; once referred to
increases in the money supply (monetary inflation); however, economic debates about the
relationship between money supply and price levels have led to its primary use today in
describing price inflation.Inflation can also be described as a decline in the real value of
money—a loss of purchasing power. When the general price level rises, each unit of
currency buys fewer goods and services. A chief measure of price inflation is the inflation
rate, which is the percentage change in a price index over time.
There are different schools of thought as to what causes inflation. Most can be divided into
two broad areas: quality theories of inflation and quantity theories of inflation. Many
theories of inflation combine the two. The quality theory of inflation rests on the
expectation of a seller accepting currency to be able to exchange that currency at a later
time for goods that are desirable as a buyer. The quantity theory of inflation rests on the
equation of the money supply, its velocity, and exchanges. Adam Smith and David Hume
proposed a quantity theory of inflation for money, and a quality theory of inflation for
There are three major types of inflation, as part of what Robert J. Gordon calls the
Demand-pull inflation: inflation caused by increases in aggregate demand due to
increased private and government spending, etc. Demand inflation is constructive to
a faster rate of economic growth since the excess demand and favourable market
conditions will stimulate investment and expansion.
Cost-push inflation: also called quot;supply shock inflation,quot; caused by drops in
aggregate supply due to increased prices of inputs, for example. Take for instance a
sudden decrease in the supply of oil, which would increase oil prices. Producers for
whom oil is a part of their costs could then pass this on to consumers in the form of
Built-in inflation: induced by adaptive expectations, often linked to the
quot;price/wage spiralquot; because it involves workers trying to keep their wages up (gross
wages have to increase above the CPI rate to net to CPI after-tax) with prices and
then employers passing higher costs on to consumers as higher prices as part of a
quot;vicious circle.quot; Built-in inflation reflects events in the past, and so might be seen
as hangover inflation.
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.The effect of inflation is not distributed evenly, and as a consequence
there are hidden costs to some and benefits to others from this decrease in purchasing
High or unpredictable inflation rates are regarded as harmful to an overall economy. 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 los from currency
inflation.Uncertainty about the future purchasing power of money discourages investment
and saving. And inflation can impose hidden tax increases, as inflated earnings push
taxpayers into higher income tax rates.
Inflation destroys the assumption that money is stable which is the basis of classic
Rising inflation can prompt trade unions to demand higher wages, to keep up with
consumer prices. Rising wages in turn can help fuel inflation.
If inflation gets totally out of control (in the upward direction), it can grossly interfere with
the normal workings of the economy, hurting its ability to supply.
Shoe Leather Cost, where people will hold their money in savings account for future
consumption and increased opportunity cost and will go to bank for frequent withdrawls
which will affect their shoe leather.
Menu Cost, with high inflation, firms must change their prices often in order to keep up
with economy wide changes. But often changing prices is i self a costly activity whether
explicitly, as with the need to print new menus, or implicitly.
This was an overview of Inflation, now let’s check out how it affects a particular industry
and what policies are followed by the industry to combat inflation.
Inflation and Automobile Industry
The country's automobile industry achieved 15-18 per cent of growth during the last five
years, but the growth rate has dipped to single digit since the last year. The big reason
behind cooling of sales is the Cost-Push Inflation of more than 12%. The industry
depends largely on metal and oil prices, both of which have increased sharply from the last
year . With crude touching 140$/barrel mark inflation tossed above 12% and daunted the
growth rates of the industry. This sector is facing the damageboth from demand and cost
side, the input cost has gone up and the demand has fallen because of soaring fuel prices.
The government and the industry have followed different policies to combat inflation.
Some of these policies have adversely affected the Industry where some have benefited the
1. Monetary Policy
Today the primary tool for controlling inflation is monetary policy. Most central banks are
tasked with keeping inflation at a low level, normally to a target rate around 2% to 3% per
annum, and within a targeted low inflation range, somewhere from about 2% to 6% per
annum. High interest rates and slow growth of the money supply are the traditional ways
through which central banks fight or prevent inflation, though they have different
approaches. For instance, some follow a symmetrical inflation target while others only
control inflation when it rises above a target, whether express or implied.
Effect: The interest rates on auto loans increased to 15-16% from12-13% and banks are
hesitating to give the loans because of fear of delinquency and customers also avoided to
take loan at increased interest rate. The auto sector of India saw good growth rates because
of good credit facilities available at optimum interest rates but as the interest rate shot up
there is decline in the demand.
Industry Specific Policy was to support their own financial institutions and increase in
the cash discounts to attract customers. These financial institutions offered loans at less
interest rates so that customers do not shy away.
2. Ban on Commodities Export
Recently another major step taken by the government was ban commodities export so asto
keep their prices down. Steel which is a major raw material used by the auto sector have
gone up significantly ,keeping this in eye the industry deferred their contracts and hedged
the commodities so as to keep their cost low. This is done by taking forward and future
contracts on that commodity index.
3. Alternative Fuel Cars
The auto industry recently came out with cars that can run on alternative fuels like CNG
and LPG because of the rising fuel prices. The customers of India are very much price
sensitive any increase in the fuel prices directly or indirectly hit their pockets and the auto
industry is very much dependent on fuel prices.The industry came out with the alternative
fuels because they are cheap and gives better mileage than the traditional fuels (petrol and
diesel) so that running cost for price sensitive customers can be reduced.
4. More Variants
Every big player of the industry came out with more number of variants to attract
customers by providing base models at low prices. The market has seen the increased
demands for small cars as they are more fuel efficient and requires less initial cost, players
like General Motors, Skoda who were primarily in operating in the luxurious segment also
launched cars for economic segment also.
5. Better Technology
Auto manufacturers are today using the improved engines in the car to increase the
efficiency and make them more economical. New improved engines are providing better
mileage and good driving experience.
6. Deferred Expansion Plans
As the cost of capital has gone up the industry has deferred it’s plan for expansion in
capacities for the time when it will come down. They are looking toward improving the
efficiency of their installed capacities by more standardization of work.
7. Increased Exports
As the demand is going down the players have decided to export the cars and sell less
domestically. Maruti Suzuki coming with A-star has decided to export the significant part
of production to other countries so that they can increase their margins.
8. Increase in Prices
Although when demand is decreasing no player woul like to increase the prices but due to
sharp increase in input prices they are forced to pass it on to customers. Auto
manufacturers have increased prices on some models.
9. Reducing Wage Bill
It is not an easy step to reduce the wage bill but if inflationary pressure continues the
companies have to resort to reducing wage bil by laying off the employees and decreasing
the salaries. Currently many companies have decided to delay their recruitmentplans to
control their wage bill.
10. Increase in Marketing
The companies like Maruti and Hyundai are coming out with new models and are hoping
that sales will pick up in the coming festive months. They are focusing on better marketing
to increase the sales despite of current inflationary pressure.