Inflation

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Inflation

  1. 1. InflationInflation is a general rise in prices of goods and services. Inflation results in loss of value of money. Ifsome commodity demands a price of 10 rupees 10 years ago, it now demands Rs. 50. This means thereis loss in value of rupee by about five times w.r.t. to that commodity. So in general all commoditiesappreciate over time. This is inflation. Inflation can be compared to nature. One talks about it but doesnothing about it.As in the case of nature, which is thus far beyond our control, one can take certain defensive measuresto offset the impacts of inflation. Hence most economies have not had much success in dealing withinflation. Two U.S. presidents (Ford and Car­ter) have referred to it as “public enemy number one”.Indian Prime Minister Dr. Manmohan Singh calls it the first priority of his government to suppressinflation below acceptable levels. Inflation remains a matter of concern because it is inevitable,per-sistent, and apparently immune to numerous remedies. Experts in the economics and numerouspoliticians have tried to give various solutions, none of which have gained absolute acceptance. Thenature is tolerated because one cannot control it; inflation is not, because it is thought to becontrollable–at least within limits.Inflation has been defined as too much money chasing too few goods. This attributes the cause ofinflation to monetary growth relative to the output of goods and services. Inflation is a persistent rise inthe general level of prices of all good and services taken together. A specific price in one commoditymay rise dramatically as in the case of oil or gas. But if this specific price is nullified by declines in pricesof other commodities, the general price level may not rise at all i.e. there is no inflation. The generallevel of prices depends on a series of individual price changes and their relative importance somemeasure of these factors, namely, a price index is required.But rise in some individual price index will not result into what is generally meant by inflation, itsconsequences won’t be particularly serious if the change in the price index quickly reversed itself andprice stability is maintained. To become and remain a problem demanding concern, it should involve along suc-cession of increases in a price index.A price index’s acceleration must take a fairly sharp increase over some previous norm or accustomedlevel–a rise that either continues to accelerate or that stays at the new higher level. From 1967 on, the
  2. 2. CPI (a form of index for measuring inflation) increased at rates well above 4% and the rate of increasehas risen steadily from 6% per annum in 1976 to about 13% in 1979-1980.Thus inflation can be defined as a sharp increase in the rate of change of a price index above anacceptable level that lasts over a time period long enough to create expectations of its futurepersistence. Inflation and economyThe rate of inflation and the economy are closely related to each other. The growth of the economy ofthe nation is judged by the growth in the Gross domestic product or the GDP but that is not enough tobe able to understand as to how many people are actually doing well because of the rise in the Grossdomestic product. The Gross domestic product is a gauge often used by the Government to show thatIndia is indeed doing well. But often these ratings are not a mirror image of what seems to be happeningin the country because the inflation rate is also a tool which helps us to witness what the common manis going through because the inflation rate carries with itself the prices of fruits, vegetables, cereals andother essential commodities which are required for daily usage.The Inflation rate in India often crosses six or seven percent. Out side of India in the developed countriesthe rates of seven percent and beyond are unheard of. But in India the inflation goes high at severaltimes. It has also led to the downfall of various governments who have been ineffective in controllingthe rate of inflation and hence have invoked the anger of the people. The economic condition of thecountry and the rate of inflation go hand in hand and they should not always be talked about as alien toeach other or not connected.And hence countries should be looking at a high GSP growth and also on the other hand, low rates ofinflation which will all be beneficial to the country and its people.No related posts. Inflation Rate
  3. 3. Since the economic reforms in 1991, the Indian economy has been growing year after year. The pastdecade and a half has seen the Gross Domestic product that is the GDP rise to scorching height. Butthe downside is that in the past few years, the inflation rate has also been going up which a cause ofconcern for the economists as well as the members of the Government. Thus this high growth ofeconomy has also been a reason for the rise in the Inflation rates.The inflation rates are closely monitored by the Government for it is the inflation rate that has a directimpact on the common man. The Gross domestic product or the GDP may be extremely high but itmay not have a direct impact on the common man where as the inflation rate surely does. Thus a highinflation rate is detrimental to the overall growth of the country and hence should be avoided. TheReserve bank of India or the RBI takes effective steps in order to reduce the rate of inflation wheneverit reaches alarming heights. Inflation has a direct impact on the prices of fruits, vegetables and otherbasic necessities. The Reserve bank if India some times increases the cash reserve ratio or the CRR inorder to arrest the rampaging rate of inflation.The rate of Inflation if within the range of two o four percent is said to be moderate but once it startsto grow beyond the five percent it raises the alarm bells. India has at times witnessed an inflation rateof greater than seven percent as well and touching eight or nine percent. In such circumstances, theGovernment gets under tremendous pressure to start trying to reduce the rate of inflation.No related posts. Inflation In WorldTo be able to understand the rate of inflation in the World, we would have to be looking individually atthe inflation rates of the countries. Almost all around the World the inflation seems to be going high ascompared to what the inflation rates were perhaps about a decade or two back. The central banks ofrespective countries have been trying hard to be able to reduce the inflation rate in their respectivecountries and hence curb the effects of inflation. As per the data of the year 2007, such was thescenario of the inflation rates around the World.In entire North America, that is the parts of the United States of America, Canada in the north andMexico, the inflation rates were managed at a healthy two to five percent. But in South America it wasa different story altogether with most of the countries displaying a very high rate of inflation ascompared to parts of North America with the inflation rates going above the mark of fifteen percent inmany countries. In parts of India and the nearby countries of Pakistan, Nepal and Bhutan all belongingto the Indian subcontinent, the inflation rates at an average were found out to be between five to tenpercent. In parts of china the inflation rates were a bit lower than that.In all the parts of Europe, the inflation rate was manageable not going beyond the mark of fivepercent. But in parts of Africa, many countries had inflation rates above ten percent. Zimbabwe hasseen the inflation rate going upward every year for the past few years. In Australia and New Zealand,the rate of inflation was again below five percent whereas in parts of Russia, it was more than tenpercent.
  4. 4. How inflation is measuredTo measure inflation, a number of goods that are representative of the economy are put together intomarket basket. It is then compared over time. This results in a price index. Price index shows thechanges in the cost of the present market basket as a percentage of the cost of that identical basketin the previous year.There are two main price indexes that measure inflation:Consumer Price Index (CPI) – A measure of price changes in the retail market of consumer goodsand services such as petrol, food, clothing and automobiles. The CPI measures price change from theperspective of the retail buyer. It is the real index for the common people. It reflects the actualinflation that is borne by the individual. This is not taken into consideration in India.Wholesale Price Index (WPI): It is used in India. It takes into account the rise in prices of goodsand services in a select range of goods and services at the wholesale level. Since the general publicdoes not buy at the wholesale level, it does not give the actual feeling of the amount of pressureborne by the general buyer. But the increase in wholesale prices does affect the retail prices and assuch give a feeling of the consumer prices.Producer Price Indexes (PPI) – A group of indices that measure the average change over time inselling prices by producers of goods and services. They measure price change from the point of viewof the seller.Cost-of-living indices (COLI): These show the fixed incomes and contractual incomes based onmeasures of goods and services price changes.In the long run, the various PPIs, WPIs and the CPI show a similar rate of inflation. In the short runPPIs often increase before the WPI and CPI. Investors generally follow the CPI more than the PPIs. InIndia WPI is used instead of CPI. Inflation controlControlling inflation is one of the most important objectives of government economic policy in manycountries. Effective policies to control inflation focus on the causes of inflation in the economy.Monetary policy controls the growth of demand by creating an increase in interest rates and areduction in the real money supply.Higher interest rates reduce aggregate demand in three main ways:• Discouraging borrowing by both households and organizations.• Increasing the rate of saving. Thus people will save more and spend less. Thus money in the marketwill be less
  5. 5. • The rise in mortgage interest payments will reduce homeowners‘ real ‗effective‘ disposable incomeand their ability to spend. Increased mortgage costs will also reduce market demand in the housingmarket• As the cost of borrowing will increase business investment may also decrease.The government generally alters the fiscal policy to fight inflation:• It increases the direct taxes thus causing a fall in disposable incomeIt lowers spending which decreases demandExchange rate appreciation:An appreciation in the currency makes exports more expensive and reduces the volume of exports andboosts supply thereby reducing aggregate demand. It also demands firms to keep costs down toremain competitive in the world market. A stronger currencies reduces import prices. This makes rawmaterials and components cheaper.Labour market reforms:The weakening of trade union strength, the growth of part-time and temporary workforce along withthe concept of flexible working hours have increased flexibility in the job market. This helps getmaximum productivity out of individuals and companies.Supply-side reforms:Supply side reforms seek to increase the productivity of the economy in the long run and raise therate of growth of capital productivity. Productivity helps to control unit costs and eases pressure onproducers to raise their prices. Food inflationThe rise in prices of edible commodities is called food inflation. Today, we are going through the worselevel of inflation in the last 17 years. The overall rise in food prices in 2007 in the U.S., according tofederal statistics, seems to be bearable — 4 percent. But it is the highest rate since the early 1990s,and it is more than the pay raises most people are receiving and it definitely seems to be gettingworse.The most significant part is that prices for many staples are rising much faster than the overallconsumer price index for food. Eggs are 25 percent milk is up 13 percent, cheese nearly 15 percentcostlier than a year ago. In Pakistan and Thailand, paramilitary troops have been deployed to preventfood theft from farms and storehouses.World Bank president Robert Zoellick warned that 33 countries are at risk of social agitation becauseof rising food prices. Much of this rise is being attributed to the diversion of food-crops into energygeneration .For example; maize is extensively used to make bio-diesel. This causes a lot of pressureon maize prices which then cause all the commodities to go up. Also, a lot of farms in Brazil are nowcultivating plants like jathropa which is used to make bio diesel, instead of food grains.This is creating scarcity of food grains in the world market shooting up prices. Countries like Indiahave placed severe restrictions on export of food grains from their country causing a speculativeinterest in commodities all over the world. Thailand, which is largest exporter of rice in the world, isnot able to export enough of it. This has led to two fold increase in the price of rice.
  6. 6. Effects of InflationA small amount of inflation is viewed as having a beneficial effect on the economy. One reason for thisis that it is generally difficult to renegotiate prices and wages once they are fixed to a level. Withincreasing prices it is easier for relative prices to adjust automatically.Because of inflation, the price of any given good is likely to rise over time, hence consumers andbusinesses may choose to make purchases sooner than later before the worth of their money haseroded. This effect will keep an economy active in the short term by encouraging spending andborrowing. But inflation also reduces incentives to save, so the effect on savings and investments isnegative. High or unpredictable inflation rates are regarded as bad.Following are effects of inflation on individual, organizations and government:Redistribution of wealth:Inflation redistributes wealth from those on fixed incomes, such as pensioners, and shifts it to thosewho do not have a fixed income (income which takes into account cost of living), for example fromwages and profits which may keep pace with inflation.Individuals who are indebted in any way may be helped by inflation because of decrease in the realvalue of debt. As such, inflation siphons off wealth from those who lend to those who borrow.Income tax brackets tend to become distorted. Governments that allow inflation to rise sharply are, ineffect, allowing a tax increase because the same real purchasing power is being taxed at a higher rate.Distorted Economic Decisions: If there is higher inflation, manufacturers that do not adjust theirprices will have much lower prices relative to firms that adjust them. This will distort economicdecisions. For eg: suppose iron ore prices rise while steel prices do not then steel manufacturers mightwant to buy steel available through other sellers rather than manufacturing themselves.Rising inflation prompts workers to demand higher wages, to keep up with prices. Rising wages causemore money supply in the market which helps inflation rise. This can cause a spiral in wage andinflation. Cause of InflationInflation is a monetary phenomenon .It is also affected by the fluctuations of wages, prices andinterest rates. There are two schools of thought which define the causes of inflation. In monetaristschool of thought, the availability of money in the market causes rise in prices of goods and servicesand prices and wages adjust quickly to make other factors merely marginal. In the Keynesian view,prices of goods and wages adjust at their own rates, which fluctuate real output.There are three major types of inflation:Demand-pull inflation: Here inflation is supposed to be caused by increases in aggregate demanddue to availability of excess money which can be because of increased private and governmentspending, etc.Cost-push inflation: It is caused by drops in aggregate supply due to increased prices of inputs. Foreg: a sudden decrease in the supply of oil, which would increase oil prices. Manufacturers for whom oilis a part of their costs will then pass this on to consumers in the form of increased prices.
  7. 7. Built-in inflation: It is induced by expectations, inked to the ―price/wage spiral‖ because it consistsof workers trying to keep their wages up with prices and then employers passing higher costs on toconsumers as higher prices .This forms a ―vicious cycle.‖According to Monetarists inflation is caused by an increase in the amount of money in market relativeto the capability of the economy to supply. This happens when governments finance spending in acrisis, such as a civil war, by printing money excessively, often leading to hyperinflation, a conditionwhere prices can double in a month or less. The current rise in inflation all over the world is said to bebecause of this theory. To subvert the possibility of a sub prime crisis the Federal Reserve (CentralBank Of the U.S.) is printing excessive money and introducing large supply of cash in the market. Thisexcessive supply is being used by people to buy more goods. This results in rise in demand of thegoods thereby increasing their prices.

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