Inflation

1. INFLATION
THE MOST INIQUITOUS TAX
ABV-INDIAN INSTITUTE OF INFORMATION
TECHNOLOGY AND MANAGEMENT
GWALIOR-474 015
Submitted By:
Irita Mishra
Kartikay Randev
Shaheen Ansari
Supratik Deb
2016

2. In economics, ‘Inflation’ means a sustained increase in general price of goods and
services in an economy over a period of time. But for any person living in that economic
situation, it implies the reduction in purchasing power per unit of money or currency, to
be specific. In other words, it can be referred to as a loss of real value in the medium of
exchange and unit of account within the economy. A chief measure of quantifying
inflation is the inflation rate which is basically the annualized percentage change in a
general price index over time which is usually the consumer price index. Also, increase
in the price level erodes the real value of money with an underlying monetary nature. A
debtor having fixed nominal rate of interest will see reduction in the real interest rate as
the inflation rate rises. In terms of taxation policies of the Government, inflation is an
indirect effect of it. For example, tax cuts have the probability to slow down economic
growth by increasing budget deficits. Moreover the effects of budget deficits was well
seen in the year 1974 by the Indians i.e. the post war scenario of 1971. The average
inflation rate was as high as 28.54%.
Put in simple words, inflation is the phenomenon through which average prices of goods
and services rise over time for a certain period. It is measured on a monthly basis and
then averaged for twelve months.
The monetary authority of India i.e. the RBI, controls the complete supply of money
through interest to maintain the price stability and economic growth. Price Stability
implies promoting economic development with considerable emphasis on price
constancy. One of the most important functions of RBI is controlling the expansion of
bank credits and money supply with proper attention to seasonal requirement for credit
without affecting the output. The instruments of monetary control implemented by the
RBI are enunciated here. RBI offers the Government securities for the control flow of
credits and buys the Government securities to increase credit flow. Higher the Cash
Reserve Ratio (CRR) with RBI, lower will be the liquidity in the system and vice versa.
RBI is empowered to vary CRR between 15 % and 3%. The bank rate also known as
the discount rate, is the rate of interest charged by the RBI for giving funds or loans to
the bank system. Funds are provided either through lending directly or discounting or
buying money market instruments like commercial bills and treasury bills. Repo rate is

3. the rate at which RBI lends to its clients generally against Government securities.
Reduction in Repo rate allows the RBI to get money at a cheap rate and increase in
Repo rate discourages the RBI to get money as the rate increases and becomes
exclusive. Reverse Repo rate is the rate at which RBI borrows money from the
commercial banks.
All of these authorities are a mixed outcome for multi-asset investors. The central banks
are searching for even more diverse and creative solutions to achieve their mandates.
The experimentation with “treasure” policies will continue for long as RBI faces the limit
of a lower bound on policy rates. One thought that has achieved traction is the direct
monetization of fiscal stimulus by RBI (i.e., helicopter money). Economist and market
players point to a magnificent shift in emphasis between inflation and growth of Indian
economy. The RBI is unexpectedly cutting rates to show to the consumer that inflation
is decreasing.
The Government of India influences the expenditure of its citizens through its fiscal
policies and collects revenue mainly through taxes. Inflation has led to the toppling over
of the dominoes of aggregate demand, level of economic activity and economic
distributions. In times like these when inflation has reached a new peak, it is the fiscal
policies that hold the key to easing out the trepidation of the masses. The Government
has been trying to sculpt a robust framework of trade, finance, transport,
communications and real estate since private consumption and internal demand are the
main drivers of growth in the country. This can be explained by acknowledging the
importance of satisfying structural demand and unlocking large scale infrastructure
projects.
The "Make in India" program launched by PM Narendra Modi focuses on tilting the
economies towards regional and domestic demand, rather than relying on exports. It is
a great step towards opening the gates of India for business and assuring increased
trust of the World Bank. Since each Government lives off its supporters' votes, price rise
is the single most important factor that concerns the citizens with regard to inflation. To
them, all other factors branch out as sub-influences. An inflation targeting policy with a
supportive fiscal stance is urgently needed in the country. Explicitly taking into account

4. the impact of inflation on the incomes and costs of commodities is the first step in the
right direction. Containing unproductive responses through "Minimum Government and
Maximum Governance” seems to be the next step. Curbing the off-shoring of black
money and dealing with supply bottlenecks is another brilliant step in the way. A
comprehensive framework needs to be formulated by the Government in dealing with
the devil of inflation.
No one is happy when they get that dreaded mail from the Income tax department,
urging everyone to pay their share of the taxes before the end of the financial year. In
times like these, the New Pay Commission doesn't mean that you're richer because
your purchasing power doesn't actually increase. Inflation leads of weakening of the
Rupee. In the end, your earnings are worth the same as they always were. Moreover,
you end up paying more since the Income tax department hasn't factored in the effect of
inflation on the tax brackets. Who knew that the direct tax also had a hidden
component, namely inflation? A salary hike from the 20% tax bracket to 30% might
make you feel richer but increase in the customer price index (CPI) means that your
elevated income has been chewed away by inflation.
An asset bought at ₹3 crores in 2000 may be selling at double the value in 2016. An
organisation may believe that this is monetarily advantageous for it. But the fact is that
the value of Rupee has fallen in 16 years. Increase in the market value of the asset
does not mean an increase in its intrinsic value. The exchange rate was around ₹45 per
dollar in 2000 while it oscillates around ₹70 now. Indian companies are hence at a loss
in the foreign market because an investment of ₹1 crore equals a reduced amount
worth US $70,000 which is the income of a typical middle class American household.
An unwanted export slump, falling input prices, escalating labour wages and an
increasing cost base have been latently instrumental in tying the hands of these
corporations and making them helpless under the wrath of inflation. The Government
has tried to compensate higher import rates and unbalanced cycles of supply and
demand with higher interest rates but inflation has taken a serious toll, especially on the
relatively small businesses across the country and beyond its borders.

5. High inflation is highly undesirable for the people in the economy. It reduces your
purchasing power and makes you spend more for smaller quantities and all these
happen due to increase in expenditure in the economy. But on the contrary, inflation is
also necessary or else stagflation may come into play which is highly infectious to the
economy of a nation. Growth of the country will be in an undecipherable hiatus. So,
there should be a controlled situation in the economy. Now, the instruments that the
Government can use to control the inflation rate are the high interest rate, high reserve
requirements and selling out Government bonds. Each of them has a different style of
impact over the purchasing power of the people.
Situations can be similar to these three types:
1. Banks borrow money from the Government at the rates fixed by Reserve bank of
India which means the banks will lend money at a higher rate. So if RBI
increases the interest rates, the banks will also follow and hence very few people
will intend to borrow money from any bank. This will directly impact the spending
money; prices will fall and hence lower the inflation.
2. Banks must maintain certain amount of cash in reserve to cover withdrawals. So,
technically, more the reserve a bank holds, fewer is the amount it will lend to
people. Ultimately consumers borrow less and spending slows.
3. Finally the Government can call in the debts that are owed or increase the
interest a bond pays, so more investors will buy them. Both of the tactics take
cash from the pockets of the bank whether it is an investor or a company. This
brings cash back to the Government and makes it stronger in cash reserve.
Government and Reserve Bank of India conjointly have the power to execute these
tools which can be termed as ‘Contrary Monetary Policy’.
In 2008, a situation arose in USA when the economy was overcome with low Gross
Domestic Product (GDP) and high prices of commodities. People were losing their
purchasing power when the Government came forward with a new act i.e. The

6. Economic Stimulus Act of 2008. According to this act, citizens of USA were given a sum
of $600 each and $200 for each couple separately so as to boost the purchasing power
of the people. The act actually helped the Americans to come out of their misery. In
short, high inflation has the potential to destroy an economy and ingenious actions like
this one help the suffering country in unfathomable ways. A similar situation was faced
by India too during the post war scenario of 1971. India had seen an inflation rate of
28.5% then (highest in the nation’s history). That situation was due to the deficit created
by borrowing of money for war purposes. The Government controlled the situation and
recovered with time. Another such situation was expected to arise after
‘Demonetization’ in India. But this time, it was about lowering the inflation. When RBI
clearly announced in the bimonthly report of its meeting on December 7th that the
interest rates will be unchanged, it clearly executed its power and control over the
economy of the nation.
Inflation affects all sections of the society and the market too. But it affects the poorest
the most because they are the most handicapped in dealing with inflated prices as
compared to the richer sections of the society. Inflation consequences in the most
inequitable distribution of income. It is a regressive tax and is hence aptly called the
most iniquitous tax of all.