The term "inflation" originally referred to increases in the amount of money in circulation. However, most economists today use the term "inflation" to refer to a rise in the price level.Inflation simply refers to "an increase in the price you pay for goods." In other words, a decline in the purchasing power of your money".
How Inflation is measured inIndia?Inflation is calculated as percentage change in CPI in two periods. Hence, Inflation (%) = (CPI2- CPI1)*100/CPI1Where, CPI1 = CPI in the previous period and CPI2 = CPI in the current period (Consumer Price Index)
How Inflation is measuredin India?In India, inflation is calculated on a weekly basis. India uses the Wholesale Price Index (WPI) to calculate and then decide the inflation rate in the economy. WPI is the index that is used to measure the change in the average price level of goods traded in wholesale market The Indian government has taken WPI as an indicator of the rate of inflation in the economy Present Rate of Inflation in India:9.8% as on Aug 2011
Causes of Inflation1. Over-expansion of money supply i.e. excess liquidity in the economy leads to inflation because “too many money would be chasing too few goods”.2. Expansion of Bank Credit Rapid expansion of bank credit is also responsible for the inflationary trend in a country.3. Deficit Financing: The high doses of deficit financing which may cause reckless spending, may also contribute to the growth of the inflationary spiral in a country.4. A high population growth leads to increase in demand and money income and cause a high price rise.5. Excessive increase in the price of fuel or food products due to political, economic or natural reasons will lead to inflation for short- as well as long-term.
Effects of Inflation oneconomyInflation is the increase in the price of general goods and service. Thus, food, commodities and other services become expensive for consumption. Inflation can cause both short-term and long-term damages to the economy; most importantly it causes slow down in the economy.1. People start consuming or buying less of these goods and services as their income is limited..2. Banks will increase interest rates as inflation increases otherwise real interest rate will be negative.3. Rising inflation can prompt trade unions to demand higher wages, to keep up with consumer prices. Rising wages in turn can help fuel inflation.4. Inflation affects the productivity of companies. 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.5. Higher interest rates leads to shutdown in the economy
Monetary policy of RBI to controlinflation & various monetary tools: CRR(Cash Reserve Ratio):Cash reserve Ratio (CRR) is the amount of Cash(liquid cash like gold) that the banks have to keep with RBI. This Ratio is basically to secure solvency of the bank and to drain out the excessive money from the banks. If RBI decides to increase the percent of this, the available amount with the banks comes down and if RBI reduce the CRR then available amount with Banks increased and they are able to lend more. Present CRR is ( 6% as of Sept 2011 ) SLR((Statutory Liquidity Ratio)is the amount a commercial bank needs to maintain in the form of cash, or gold or govt. approved securities (Bonds) before providing credit to its customers. SLR rate is determined and maintained by the RBI (Reserve Bank of India) in order to control the expansion of bank credit. Generally this mandatory ration is complied by investing in Govt bonds. Present SLR is 24 %.as of Sept2011
Repo Rate:Whenever the banks have any shortage of funds they can borrow it from RBI. Repo rate is the rate at which our banks borrow rupees from RBI. A reduction in the repo rate will help banks to get money at a cheaper rate. When the repo rate increases borrowing from RBI becomes more expensive. Present Repo Rate:8.25 % as of September 2011 Reverse Repo rate:Reverse Repo rate is the rate at which Reserve Bank of India (RBI) borrows money from banks. Banks are always ready to lend money to RBI since their money are in safe hands with a good interest. An increase in Reverse repo rate can cause the banks to transfer more funds to RBI due to this attractive interest rates. It can cause the money to be drawn out of the banking system. Present Reverse Repo Rate: 7.25% as of September 2001
5. Bank Rate:Bank Rate is the rate at which RBI allows finance to commercial banks. Bank Rate is a tool, which central bank uses for short-term purposes. Any upward revision in Bank Rate by central bank is an indication that banks should also increase deposit rates as well as Base Rate/ Benchmark Prime Lending Rate(BPLR). Thus any revision in the Bank rate indicates that it is likely that interest rates on your deposits are likely to either go up or go down, and it can also indicate an increase or decrease in your EMI.