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  1. 1. Inflation in Market Economies Causes and Control Presented by: Bharat Jhalani July 2008
  2. 2. Contents <ul><li>Meaning </li></ul><ul><li>Inflation and Unemployment </li></ul><ul><li>Inflation and Investments </li></ul><ul><li>Measures of Inflation </li></ul><ul><li>Causes of Inflation </li></ul><ul><li>Controlling Inflation </li></ul><ul><li>Hyper-inflation </li></ul>
  3. 3. Meaning <ul><li>One of the most important economic concepts is inflation. </li></ul><ul><li>Inflation is a rise in general level of prices of goods and services over time. </li></ul><ul><li>As the cost of goods and services increase, the value of a currency is going to go down because you won't be able to purchase as much with that currency as you could have last month or last year. </li></ul>
  4. 4. Inflation and Unemployment <ul><li>Modern economists believe that inflation is inversely related to unemployment. </li></ul><ul><li>As inflation decreases, unemployment is expected to rise and vice-versa. </li></ul>
  5. 5. Inflation and Investments <ul><li>Inflation is greatly feared by investors because it grinds away at the value of your investments. </li></ul><ul><li>If you invest $.100 in a 1-year CD that will re 5% over that year, you will be giving up $100 right now for $105 in 1 year. If over the course of that year there is an inflation rate of 6%, the purchasing power of $100 has decreased by $6, and you have actually lost ground! (Of course, the capital gains tax you pay on your &quot;gain&quot; will increase this loss.) </li></ul>
  6. 6. Measures of Inflation <ul><li>Inflation is measured by calculating the percentage rate of change of a price index, which is called the inflation rate. </li></ul><ul><li>This rate is calculated by mainly two different price indices: </li></ul><ul><li>1. Wholesale price index </li></ul><ul><li>2. Consumer price index </li></ul>
  7. 7. Wholesale price index <ul><li>WPI is the index that is used to measure the change in the average price level of goods traded in wholesale market. </li></ul><ul><li>India uses the WPI to calculate and then decide the inflation rate in the economy. </li></ul><ul><li>WPI does not properly measure the exact price rise an end-consumer will experience because, as the name suggests, it is at the wholesale level. </li></ul>
  8. 8. Consumer price index <ul><li>CPI is a measure of a weighted average of prices of a specified set of goods and services purchased by consumers. </li></ul><ul><li>It is a price index that tracks the prices of a specified basket of consumer goods and services, providing a measure of inflation. </li></ul><ul><li>Most developed countries uses this index. </li></ul>
  9. 9. Causes <ul><li>There are three major types of inflation categorized by the causes: </li></ul><ul><li>1. Demand-pull inflation </li></ul><ul><li>2. Cost-push inflation </li></ul><ul><li>3. Built-in inflation </li></ul>
  10. 10. Demand-pull inflation <ul><li>inflation caused by increases in aggregate demand due to increased private and government spending, etc. </li></ul><ul><li>Demand inflation is constructive to a faster rate of economic growth since the excess demand and favourable market conditions will stimulate investment and expansion. </li></ul>
  11. 11. Supply shock inflation <ul><li>caused by drops in aggregate supply due to increased prices of inputs </li></ul><ul><li>E.g.: 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 increased prices. </li></ul><ul><li>supply-shock inflation involves a trickle down effect that will cause changes in many sectors of the marketplace </li></ul>
  12. 12. Built-in inflation <ul><li>induced by adaptive expectations, often linked to the &quot;price/wage spiral&quot; 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; </li></ul>
  13. 13. Seigniorage <ul><li>The “revenue” raised from printing money is called seigniorage (pronounced SEEN-your-ige) </li></ul><ul><li>To spend more without raising taxes or selling bonds, the govt can print money. Higher the money supply, higher the inflation. </li></ul>
  14. 14. Controls <ul><li>Inflation is a hydra header monster. It cannot be controlled by taking a single measure. However, if monetary and fiscal measures are wisely coordinated, it can greatly help in controlling the continuous process of rising prices. </li></ul>
  15. 15. Monetary policy <ul><li>Monetarists emphasize increasing interest rates (slowing the rise in the money supply) to fight inflation. </li></ul><ul><li>Rates consists of: </li></ul><ul><li>1. CRR </li></ul><ul><li>2. Bank rate </li></ul><ul><li>3. Repo rate </li></ul><ul><li>4. Reverse Repo rate </li></ul>
  16. 16. Fiscal policy <ul><li>Keynesians emphasize reducing demand in general through fiscal policy. </li></ul><ul><li>Increase taxes so less disposable income </li></ul><ul><li>Reduce government spending to reduce demand. </li></ul><ul><li>changing the import and export duties </li></ul>
  17. 17. Exchange rate <ul><li>By strengthening local currency against dollar will boost imports while discouraging exporters. </li></ul><ul><li>Through selling of dollars. </li></ul><ul><li>Example:- In the week ending June 13, RBI sold almost $5 billion from its reserves in the open market. </li></ul>
  18. 18. Budgetary measures <ul><li>The budgetary deficit should be kept low level. </li></ul><ul><li>The government should give special attention to the production of cottons, wheat, vegetables, edible oil etc. it will have soothing effects on inflating. </li></ul>
  19. 19. Hyper-inflation <ul><li>Zimbabwe: 355,000%! </li></ul><ul><li>The inflation in Zimbabwe for the month of March 2008 rose to 355,000%! Yes, 355,000 per cent! It more than doubled from the February figure of 165,000%.. </li></ul>
  20. 20. Contd. <ul><li>Almost 80% of the nation is unemployed. </li></ul><ul><li>The Zimbabwean central bank has introduced $500 million bearer cheques (or currency notes) for the public, and $5 billion, $25 billion, $50 billion agro-cheques for farmers. </li></ul><ul><li>The nation had introduced $250 million bearer cheques. </li></ul>
  21. 21. Contd. <ul><li>A sausage sandwich sells for Zimbabwean $50 million. </li></ul><ul><li>A 15-kg bag of potatoes cost Zimbabwean $260 million. </li></ul><ul><li>But then, Zimbabwean $50 million is roughly equal to US$ 1 </li></ul>