1) Inflation refers to a general rise in prices for goods and services over time which decreases the purchasing power of currency. The two main causes of inflation are demand-pull, when demand exceeds supply, and cost-push, when input costs rise. 2) Remedies for inflation include contractionary monetary policy which raises interest rates, fiscal policy like increasing direct taxes and decreasing spending, and supply management measures. Inflation is measured using indices like WPI, CPI, and GDP deflator. 3) Deflation is a general decrease in prices over time which increases purchasing power. It can be caused by structural changes, increased productivity, or a decrease in currency supply. Deflation lowers

1. UNIT - 2
Economic
Fluctuations

2. INFLATIONS :
Inflation refers to the rise in the prices of most goods and services of daily or common use, such as food, clothing,
housing, recreation, transport, consumer staples, etc. Inflation measures the average price change in a basket of
commodities and services over time. Inflation is indicative of the decrease in the purchasing power of a unit of a
country’s currency. This is measured in percentage.
What are the main causes of inflation?
There are two primary types, or causes, of inflation:
•Demand-pull inflation occurs when the demand for goods and services in the economy exceeds the economy’s ability to
produce them. For example, when demand for new cars recovered more quickly than anticipated from its sharp dip at the
beginning of the COVID-19 pandemic, an intervening shortage in the supply of semiconductors made it hard for the
automotive industry to keep up with this renewed demand. The subsequent shortage of new vehicles resulted in a spike in
prices for new and used cars.
•Cost-push inflation occurs when the rising price of input goods and services increases the price of final goods and
services. For example, commodity prices spiked sharply during the pandemic as a result of radical shifts in demand,
buying patterns, cost to serve, and perceived value across sectors and value chains. To offset inflation and minimize
impact on financial performance, industrial companies were forced to consider price increases that would be passed on to
their end consumers.

3. Remedies to Inflation :
The different remedies to solve issues related to inflation can be stated as:
• Monetary Policy (Contractionary policy)
The monetary policy of the Reserve Bank of India is aimed at managing the quantity of money in order to meet the
requirements of different sectors of the economy and to boost economic growth.
This contractionary policy is manifested by decreasing bond prices and increasing interest rates. This helps in reducing
expenses during inflation which ultimately helps halt economic growth and, in turn, the rate of inflation.
• Fiscal Policy :
• Monetary policy is often seen separate from fiscal policy which deals with taxation, spending by government and
borrowing. Monetary policy is either contractionary or expansionary.
• When the total money supply is increased rapidly than normal, it is called an expansionary policy while a slower
increase or even a decrease of the same refers to a contractionary policy.
• It deals with the Revenue and Expenditure policy of the government.
Tools of fiscal policy :
1. Direct Taxes and Indirect taxes – Direct taxes should be increased and indirect taxes should be reduced.

4. 1.Public Expenditure should be decreased (should borrow less from RBI and more from other financial institutions)
Supply Management measures :
• Import commodities that are in short supply
• Decrease exports
• Govt may put a check on hoarding and speculation
• Distribution through Public Distribution System (PDS).
Measurement of Inflation :
1.Wholesale Price Index (WPI) – It is estimated by the Ministry of Commerce & Industry and measured on a monthly
basis.
2.Consumer Price Index (CPI) – It is calculated by taking price changes for each item in the predetermined lot of
goods and averaging them.
3.Producer Price Index – It is a measure of the average change in the selling prices over time received by domestic
producers for their output.
4.Commodity Price Indices – It is a fixed-weight index or (weighted) average of selected commodity prices, which may be
based on spot or futures price

5. 5. Core Price Index – It measures the prices paid by consumers for goods and services without the volatility caused by
movements in food and energy prices. It is a way to measure the underlying inflation trends.
6. GDP deflator – It is a measure of general price inflation.
Effect of Inflation on the Economy :
The effect of inflation on the economy can be stated as:
• The effect of inflation is not distributed evenly in the economy. There are chances of hidden costs for different goods and
services in the economy.
• Sudden or unpredictable inflation rates are harmful to an overall economy. They lead to market instability and thereby
make it difficult for companies to plan a budget for the long-term.
• Inflation can act as a drag on productivity as companies are forced to mobilize resources away from products and
services to handle the situations of profit and losses from inflation.
• Moderate inflation enables labour markets to reach equilibrium at a faster pace.

6. DEFLATION :
When the overall price level decreases so that inflation rate becomes negative, it is called deflation. It is the opposite
of the often-encountered inflation.
EXPLANATION :
Deflation is when consumer and asset prices decrease over time and purchasing power increases. Essentially, you can
buy more goods or services tomorrow with the same amount of money you have today. This is the mirror image
of inflation, which is the gradual increase in prices across the economy.
While deflation may seem like a good thing, it can signal an impending recession and hard economic times. When
people feel prices are headed down, they delay purchases in the hopes that they can buy things for less at a later date.
But lower spending leads to less income for producers, which can lead to unemployment and higher interest rates.
This negative feedback loop generates higher unemployment, even lower prices and even less spending. In short,
deflation leads to more deflation.

7. Causes of Deflation :
Deflation can be caused by multiple factors:
Structural changes in capital markets : When different companies selling similar goods or services compete,
there is a tendency to lower prices to have an edge over the competition.
Increased productivity: Innovation and technology enable increased production efficiency which leads to
lower prices of goods and services. Some innovations affect the productivity of certain industries and impact the
entire economy.
Decrease in the supply of currency : The decrease in the supply of currency will decrease the prices of
goods and services to make them affordable to people.
Effects of Deflation :
Deflation may have the following impacts on an economy:
Reduction in Business Revenues : In an economy faced with deflation, businesses must drastically reduce
the prices of their products or services to stay profitable. As reductions in prices take place, revenues begin to
drop.
Lowered Wages and Layoffs : When revenues begin to drop, businesses need to find means to reduce their
expenses to meet objectives. One way is by reducing wages and cutting jobs. This adversely affects the

8. How To Measure Deflation?
There are two methods to measure the impact of deflation, the first one being the Wholesale Price Index
(WPI) and the second Consumer Price Index (CPI). Keep in mind with CPI, you won’t be able to factor in
stock prices which are considered to be an important economic indicator.
For example, retired professionals often invest their money in stocks to make stock purchases. At the same
time, a business will be using this investment for its fund growth. As a result, measuring deflation has to be
done by calculating the WPI instead of CPI in most cases.
WPI is the difference between the wholesale price and the retail price. These will include prices that are
charged by the manufacturer, and they are reported monthly to track down the overall rate of change in
the manufacturer’s costing and the wholesale pricing.
The index is set to 100 for the base period, and it will be calculated on subsequent price changes to find
out the aggregate output of the goods.
For explanation purposes, let’s take January 2022 as the base period. Now during this time, if the
aggregate prices of goods go up to 10.5% over the next year. Then WPI for January 2023 is going to be
110.5.

9. STAGFLATION :
Stagflation is a rare economic phenomenon that combines two or three negative economic trends that
normally do not occur together: high inflation, poor growth and rising unemployment. It has only occurred two
or three times in the past 100 years. But when stagflation does arrive, it is very hard to overcome because
the monetary policy tools typically used to defeat one of those trends tend to make the others worse.
Stagflation can create so much misery for the people living through it that economists call one tool they use
to measure it the “Misery Index.”
What Is Stagflation?
“Stagflation” is a portmanteau word combining “inflation” and “stagnation.” An economy in stagflation has high
consumer price inflation, low economic growth and, usually, rising unemployment. The word was coined by
the British politician Iain Macleod in 1965 to describe the state of the U.K. economy at that time; it was
subsequently adopted by U.S. politicians to describe the U.S. economy of the 1970s.
Stagflation is highly unusual because high inflation and low economic growth are contradictory trends —
inflation, by its nature, typically occurs alongside economic booms.
Stagflation vs. Inflation: Inflation is defined as a rise in the general level of consumer prices. Stagflation is
the combination of generally high and rising consumer prices with low, absent or even negative economic
growth.

10. Stagflation is the
combination of poor
economic growth and
high inflation, usually
accompanied by rising
unemployment.

11. Key Takeaways :
• Stagflation is the combination of high consumer price inflation and stagnant economic growth,
usually accompanied by rising unemployment.
• It can be caused by a supply-side shock, such as sharply rising oil prices, or by poor economic
policies, such as too-high government spending or too-low interest rates.
• A wage-price spiral is typical of stagflation caused by poor monetary policy.
• The “Misery Index,” which combines inflation and unemployment, is a measure of stagflation.
• The best-known example of stagflation occurred during the 1970s in the U.S. and U.K. Other
examples include the period after the 2008 financial crisis in the U.K.
• Curing stagflation can be difficult if it has become entrenched.

12. How Does Stagflation Work?
Stagflation combines inflation, which lowers the purchasing power of money, with poor productivity, which lowers
economic growth. It has been described as causing “misery” because the money people have buys less and less, causing
their real cost of living to rise, while the economy’s low productivity and high unemployment prevent their wages from
rising to compensate. Stagflation erodes people’s income and savings while causing businesses to hold down wages and
hold back on investments and hiring.
In the early 1970s the American economist Arthur Melvin Okun invented the so-called “Misery Index,” which measures
the economic distress stagflation causes when inflation and unemployment combine.
What Causes Stagflation?
Economists identify two main causes of stagflation: supply-side shock and poor economic policies. These events
can occur independently, but they can also occur together and reinforce each other.
• Supply-side shock. This is typically a sharp rise in the global price of some essential commodity, such as oil.
Oil is a good example because higher oil prices increase costs for virtually all businesses. In turn, businesses
typically pass higher costs on to consumers in the form of rising prices and to workers in the form of lower wages
and/or layoffs.
As a result, both inflation and unemployment rise. Falling real incomes force households to cut back spending,
particularly on nonessential goods and services, which causes economic growth to slow or fall. In response,

13. In this scenario, the fundamental cause of the stagflation is the oil price shock; unemployment and/or under-
employment, falling real incomes and stagnant output are the result.
•The U.K. experienced this example of supply-side shock stagflation in 2010 to 2012, when high oil prices raised
inflation sharply, peaking at 5.2% in September 2011. The U.K. economy slumped, though it did not quite sink
into recession: GDP growth fell from 1.9% in 2010 to 0.7% in 2012. Unemployment, already elevated because
of the 2008 financial crisis, rose to 8.5% by the end of 2011.
•Supply-side shock inflation typically dissipates when commodity prices stop rising, though because commodity
contracts typically have long lead times, the price shock can take a year or more to unwind. In the example
above, the oil price stopped rising in April 2011, but the U.K. economy remained in stagflation until 2012.
• Supply chain disruptions, such as what happened in the COVID-19 pandemic, can also cause stagflation.
Sharp rises in shipping, railroad and haulage costs can be passed on to customers and workers in the same
way as commodity price shocks. Even if the shock itself is transitory, the ensuing stagflation can take a year or
more to unwind due to long lead times on shipping contracts.
•Poor economic policies. Stagflation can be caused by inappropriate monetary and/or fiscal policy. For
example, a government might increase taxes on businesses, sharply raise the minimum wage and/or increase
social spending. Employers facing a “double whammy” of higher taxes and higher labor costs could raise prices
for consumers, thus increasing inflation.

14. Alternatively, a government/central bank might keep interest rates too low in an economy running close to full
capacity, triggering a consumer boom that drives prices higher. Workers demand higher wages in
anticipation of higher prices; employers agree to their demands without insisting on higher output to counter
the increased labor costs because they expect to be able to pass those costs on to customers in the form of
higher prices. Consumer prices thus rise, resulting in more wage demands.
This is known as a “wage-price spiral.” Prices rise, wages rise but output stays flat, and unemployment rises
among young people entering the workforce and those with casual or insecure jobs.
• In the early 1970s, loose monetary policy and high government spending combined to create full
employment and strong economic growth in the U.S. But prices were already rising, in part because of the
suspension of the gold standard in 1971. And after the oil shock of 1973, they rose even faster. By
November 1974, CPI inflation had reached 12.2% and the U.S. was in a recession, with economic growth of
minus 1.9% and unemployment rising fast.

15. Is Stagflation Curable?
Mild stagflation caused by a supply-side shock such as an oil price rise, as happened to the U.K. economy in
the early 2010s, may cure itself once the supply-side shock passes. But other forms of stagflation can be
difficult to cure.
Cutting government spending can reduce inflation, and reducing taxes for businesses can increase output. But
if there is an entrenched wage-price spiral, then expectations of price and wage increases must be broken.
This could mean sharply raising interest rates to eliminate the cheap money that drives the spiral. That was the
shock medicine imposed by Paul Volcker, Chairman of the Federal Reserve, in the early 1980s. It cured the
U.S.’s seemingly intractable stagflation, but at the price of a very deep recession and extremely high
unemployment.

16. Concept Of Demonetisation :
The withdrawal of currencies or other valuables by the central bank to be used as the legal tender in the nation. Such
currencies either turn into scrap or a deposited in the banks and replaced by the new currencies.
Governments of many countries across the world have taken this drastic measure to curb black money and stop the
counterfeiting of currency notes. Some countries failed miserably while others were successful in their goals behind
demonetization.
Demonetisation In India :
Basic meaning:
It refers to the decision of RBI/Government to recall the status of a currency note to be used as a legal tender.
Usually, all the currencies issued by RBI can be used as a legal tender as the value they carry is promised by RBI
and once the value has been demonetized/recalled/revoked, the currency note cannot be used.
Globally the central banks follow a practice wherein older currency notes are recalled and new currency notes with
enhanced security features are issued to overcome the menace of counterfeit currency.

17. Why was demonetization done :
• To tackle the menace of black money/parallel economy/shadow economy
• The cash circulation in India is directly connected to corruption hence we want to reduce the cash transactions and
also control corruption and thereby move towards cashless transactions.
• To counter the menace of counterfeit currency
• To prevent the cash being used for terrorist activities/terror funding
• This is the only second-time post-independence (even before Independence Demonetization was done in 1946) that
the measure such as Demonetization has been announced. The last time this was done was in 1978 under the Morarji
Desai government when Rs 500, Rs 1000, and Rs 10000 notes were demonetized.
Analysis of Demonetisation in India
• Pros of Demonetization :
• The menace of black money can be controlled to some extent
• Terror financing, using black money for illegal activities, etc will all take a hit
• The counterfeit currencies which have an impact on the real economy will be rooted out
• The mobilization of deposits in the banks will increase, which may lead to increased credit flow and lowering of lending
rates

18. • The black money adds to the inconspicuous demand and hence the inflation to some extent will be under control
• The government is also aiming to raise its revenue collection (eg- by taxing exorbitant IT rates over certain deposits, the tax
collection in other forms will also increase, etc)
• Real estate is one of the major sources of black money generation. With this move, it is expected that the property market rates
may bottom out or moderate
• It’s a major step by the government towards forming a cashless economy
• The honest workers will be rewarded under such a scenario
• The elections are usually associated with black money generation and circulation, with this scheme the funding of elections
through nefarious ways will be hit
• It is expected that with this move the Fiscal Deficit of the government may come down
Cons of Demonetization
• For one all the black money is not stored in the form of cash only and secondly, the measure takes care of the result but not the
cause-black money is generated mainly because of corruption and tax evasion. This measure controls the usage of black
money but cannot control the causes
• Sudden and huge demand for the new currencies
• Panic amongst the common man (already we have seen the case wherein people have looted fair price shop in MP, Cash
Carrying companies seeking higher insurance, etc). already the panic has led to people hoarding currencies which have further
reduced the liquidity in the market
• The small trade/shopkeepers are facing difficulties
• Black marketing of the new notes/currencies is on the rise

19. • The establishments such as banks, hospitals, etc are under a lot of stress
• Another area that is a cause of worry is the likely drop in the rural demand as the cash usage will become restricted. Apart from
this, the experts are also expecting an impact on the SME sector, agricultural production (the economy was expected to perform
well as there was an expectation of a good rabi crop after two bad monsoons but a prominent economist, Pronab Sen has said
that demonetization is akin to third bad monsoon year as it will have an impact on agricultural production, but the more dangerous
situation is this having a spillover effect on to fertilizer, tractor sectors)