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Inflation by Rojan Mehta

1. Definition
2. Variations of Inflation
3. Calculation of Inflation
4. Keynisian view of Inflation/Causes of Inflation
5. Effects of Inflation
6. Methods to Control Inflation
7. Is inflation good or bad?
8. Inflation and GDP

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Inflation by Rojan Mehta

  1. 1. • Inflation means increase in the money supply or sustained increase in the general price level of goods and services in an economy normally owing to increase in money supply. • When money supply increase, price level of products increase and each unit of currency buys lower quantity of products. • As a result, inflation results in reduction in purchasing power per unit of currency. • In a more technical way, it is rise in general price level caused by an imbalance between the quantity of money and trade needs.
  2. 2. •Deflation : This is the opposite of inflation i.e. the fall in general price level of products. Many people have heard about the deflation in Chinese Economy in 2014 to current timeline. Their economy is currently in painful transition from Investment based economy to Consumer Spending. The prices of Chinese products have further decreased and Yuan Has devaluated. The markets are rapidly decreasing and they are more vulnerable. The gigantic Chinese economy will in fact effect the other economy which is based on it. American Dreams are made in China. I mean to say about the product manufacturing outsourcing to china. So, as a result, American Economy too will face the outcome. Hyperinflation : It is unusually rapid inflation. It can lead to breakdown of national economy. Most recent example is Zimbabwe in 2008 Prices doubled here every 24.7 hours in November 2008 and inflation reached levels of 79 billion-odd %. They eventually stopped using the official currency and switched to the South African Rand or the $US. A loaf of bread ended up costing $35 million. This is the most recent case. It was Mugabe’s land-redistribution program that caused this. Other unofficial case is my own country, Nepal in 2015 where due to months long strike, the prices of products nearly doubled and that of gases nearly tripled. Stagflation: It is the result of the combination of high unemployment and economic stagnation with inflation. Most recent case is of Argentina in 2012 where industrial production slumped to all time high and as result majority of population was unemployed. Stagflation was visible in the market of properties in the country. Home sales and construction declined very much and as a result even these remained out of clutches of middle class people
  3. 3. Calculation of inflation • Most countries(USA and India included) calculate the movement in price index usually called the Consumer Price Index(CPI). In US, it is calculated by Department of Labor Statistics. • In UK Retail Prices Index is used, which is more broader than CPI as it contains broader basket of goods and services. • Other widely used price indices are Producer price indices, Commodity price indices, Core Price Indices, etc. • CPI uses the data collected by surveying households to quantify the rational consumer’s spending on specific products and weigh in the average prices of those items accordingly. • To better relate over time, a base year is chosen and index of 100 is assigned. • When looking at inflation rate, Economic institution (Central Banks) only look at certain indices of specific goods to formulate the monetary policy. • Formulae: Current Index Less Base Index 100 • Base Index
  4. 4. Keynesian VIEW or Causes of Inflation: It is one of the most popular view by Keynesian economists. They propose that changes in money supply do not directly affect prices of products and apparent inflation is the result of the expression of economy itself in prices. As per this view, there are three major types of inflation: 1. Demand Pull Inflation 2. Cost Push Inflation 3. Built-in inflation This view is also popularly called Triangle Model
  5. 5. Income Redistribution: Regressive effect of inflation hits the lower income families. In a nutshell, rich becomes richer and poor becomes poorer Negative Real Interest Rates: Inflation eats up savings . If rate of savings is less than rate of inflation, the people who depends on their saving deposits will be hit severely. Cost of Borrowing: Inflation is well reflected in higher cost of borrowing also as the financial institution will also tend to reduce the impact of inflation on them through these measures Risky Environment: Business environment will be very much volatile if inflation is not stable. Stable inflation can be complied to but it takes a lot of resources to cope to risky business environment Other effects: 1. Reduction in production 2. Hoarding and Black Marketing 3. Encourages Speculation 4. Hinders Foreign Capital EFFECTS OF INFLATION
  6. 6. Monetory Policy: The central bank can increase interest rate of borrowings and make savings attractive. A higher interest rate increases exchange rate which helps to reduce inflationary position by making imports cheap and reducing demand for exports Fiscal Policy: The government could increase taxes and cut its spending . This improves the budget situation and helps to reduce demand situation in the economy. Fiscal Policy is nothing but annual budget policy generally introduced 2 months before start of new fiscal year. Wage Control: Powerful labor unions demand for higher wages which can increase inflation. Limiting wage growth can moderate inflation. However it is extremely difficult to control wages especially in developed countries due to prevalence of strong unions. Money Supply: It would take detailed study of economy to understand whether increasing money supply will control inflation or not. Recent pasts show that controlling money supply can control inflation while there has also been unsuccessful cases. Other Methods: 1.Supply side economic policies. 2. Prices Control 3. Gold and Silver Reserves METHODS TO CONTROL INFLATION
  7. 7. • Inflation is a highly debated subject. The term has has to be understood in different economic conditions separately. • However, acceptable rate of inflation is good for economy as it stabilizes economy by increasing economic output and productivity while creating opportunities for employment. • Neither low inflation nor high inflation is good for the economy. The crux would be steady rate of inflation is good as it introduces certainty perspective. • However the rate of inflation is to be seen from macroeconomic variables of economy • From above you must have got confused. So, it is really a open debate as inflation requires various angles. Every economists have
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