inflation and indian policies

7/29/2019 INFLATION and Indian Policies

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• The rise in the general price levels of goods and services in an

economy over a period of time.

• Leads to devaluation of MONEY.

• Measured in terms of Inflation Rate which is the percentage rateof change in price level over time, usually one year.



1. CREEPING INFLATION (0%-3%)

2. WALKING INFLATION ( 3% - 7%)

3. RUNNING INFLATION (10% - 20 %)

4. HYPER INFLATION ( 20% and abv)



Govemment of a country prints money in excess, prices increase as

there is too much money in circulation chasing too few goods.

Increase in production and labour costs thereby increasing the price

of the final product resulting in inflation.

When countries borrow money they have to cope with the interest

burden, resulting in inflation.

High taxes on consumer products.

When there is more demand for goods and services than what isproduced.

Non availability of a commodity leading to increase in prices.



When the balance between supply and demand goes out of control,consumers could change their buying habits forcing manufacturers tocut down production causing problems in the economy.

Price increase can worsen poverty affecting low income household.

Inflation creates economic uncertainty and reduces investmentthereby slowing growth and finally reducing savings and therebycutting consumption.

The producers would not be able to control the cost of raw materialand labor and hence the price of the final product. This could result in

less profit or in some extreme case no profit, forcing them out of business.



Wage Inflation/ Demand – Pull or Excess Demand inflation:Occurs when total demand for goods and services in an economy

exceeds the supply of the same.

Cost-push Inflation: Occurs when there is increase in the cost of

production of goods and services.

Pricing Power Inflation / administered price inflation: Occurs

when the business houses and industries decide to increase the

price of their respective goods and services to increase their profit

margins.

Sectoral lnflation: Occurs when there is an increase in the price of the goods and services produced by a certain sector of industries.

Eg. When the price of oil increases, the ticket fares would also go up.



Through soundMONETARY and FISCAL Policies.



• The Monetary and Credit Policy is the policy statement,

through which the Central Bank seeks to ensure price

stability for the economy.

The factors include - money supply, interest rates andthe inflation. Besides, the Central Bank also announces

norms for the banking and financial sector and the

institutions which are governed by it.



During recession –

consumers stop spending as much as they used to business production declines, leading firms to lay off

workers and stop investing in new capacity

foreign appetite for the country’s exports may also

fall.

In short, there is a decline in overall, or aggregate,demand to which government can respond with a

policy that leans against the direction in which theeconomy is headed. Monetary policy is often thatcountercyclical tool of choice.



Such a policy would lead to –

The desired expansion of output and employment

It entails an increase in the money supply- thus

results in an increase in prices.

The economy gets closer to producing at full

capacity, Increasing demand will put pressure on input costs,

including wages.

Increased income leads to consumption of more

goods and services, further bidding up prices andwages and pushing generalized inflation upward—an

outcome policymakers usually want to avoid.



•Central bank changing the monetary policy.

•Change the size of money supply.

•Done through open market operations.

•Federal reserve system- buys/ borrows treasury bills

-Commercial banks-central bank-cash in their accounts

(Reserves that banks keep with it – expands money supply).

•Fed- sells treasury securities –banks- payment it receives

Will reduce the money supply.

•Central banks focuses on interest rates rather than

Specific amount of money.



•Central banks- main focus- ―policy rate‖.

•It is the rate that one bank charges another to borrow funds

•When the central bank puts money into the system by buying or

borrowing securities, colloquially called loosening policy, the rate

declines.

•It usually rises when the central bank tightens by soaking up

reserves.



•Changing monetary policy has important effects on aggregate

demand, and thus on both output and prices.

•If the central bank tightens, for example, borrowing costs rise,

consumers are less likely to buy things they would normally finance—

such as houses or cars—and businesses are less likely to invest in

new equipment, software, or buildings.

•This reduced level of economic activity would be consistent with lower inflation because lower demand usually means lower prices.



• A rise in interest rates also tends to reduce the net worth of businesses

and individuals—the so-called balance sheet channel —making it tougher

for them to qualify for loans at any interest rate, thus reducing spending

and price pressures.

• A rate hike also makes banks less profitable in general and thus less

willing to lend—the bank lending channel .

• High rates normally lead to an appreciation of the currency, as foreigninvestors seek higher returns and increase their demand for the currency.

•Through the exchange rate channel , exports are reduced as they

become more expensive, and imports rise as they become cheaper.

•In turn, gdp shrinks.



•If policymakers hike interest rates and communicate that further hikes

are coming, this may convince the public that policymakers are serious

about keeping inflation under control.

• Long-term contracts will then build in more modest wage and price

increases over time, which in turn will keep actual inflation low.



•Purchase large quantities of financial instruments from the market.

•Quantitative easing increases the size of the central bank’s balance

sheet and injects new cash into the economy.

•Banks get additional reserves (the deposits they maintain at thecentral bank) and the money supply grows.

•Credit easing , may also expand the size of the central bank’s balance

sheet.

•. For instance, the fed set up a special facility to buy commercial paper

to ensure that businesses had continued access to working capital.

•The central bank ensures the flow of finance to particular parts of the

market.



•It refers to the revenue and expenditure policy of the governmentwhich is generally used to cure recession and inflation and maintain

economic stability in the country.

•During periods of recession there is not enough money circulating in

the economy. During periods of inflation, there is too much. So theanswer to these problems is to either put money in or take money out

of the economy.

• At this point, economists begin to disagree over whom should do the

putting in or taking out, and which means should be used to do so.Some favour fiscal policy while some favour monetary policy



1.REDUCTION OF GOVT. EXPENDITURE

2.INCREASE IN TAXATION

3. IMPOSITION OF NEW TAXES

4. WAGE CONTROL

5.RATIONING

6. PUBLIC DEBT

7. INCREASE IN SAVINGS

8. MAINTAINING SURPLUS BUDGET



•Fiscal policy were introduced by British economist john maynard keynes during

the great depression.

•Keynes argued, contrary to conventional thinking, that the market and the

economy could not regulate itself. During periods of recession, consumers holdon to their money rather than spending it. Businesses were similarly afraid to

expand operations and hire more workers.

•Therefore, the government needed to jump-start the economy by injecting some

money into it by lowering tax rates and increasing government spending. By

lowering taxes people had money to spend on buying cars and appliances whichput people to work stimulating even more spending and job growth.

•By increasing government spending, the government put money directly into the

economy. Building a dam, extending unemployment benefits, or hiring more

teachers also put money into circulation.



Keynes argued that during periods of recession aggregate

demand (AD)—

the total demand of consumers, businesses, and government at various price levels —needed to be stimulated through government action. Through tax cuts and increased government spending, aggregate demand (AD1)would be increased (AD2).



•The policymakers are in a debate that whose tax to be cut during the

periods of recession

•Traditional Keynesian fiscal policy emphasizes putting money into the

hands of middle and lower-class consumers, thereby stimulating the

―demand side‖ of the economy.

• Others argue that more permanent growth is achieved by cuttingbusiness and corporate taxes, and by reducing capital gains taxes and

personal income tax rates for wealthier taxpayers.

•According to these ―supply-side‖ theorists, the money saved through

these sorts of tax cuts will be reinvested in new businesses and large-scale expansion, thus generating more jobs.



•But there is doubt that cutting of taxes may lead to government

budget deficits--that is, government spending may exceed government

income.

•In response, some argue that short-term deficits are acceptable since

once the economy starts to grow, tax revenues will increase. Others

argue that deficits saddle future generations with debt and lead to high

interest rates, crippling future growth.



•The Monetary Policy regulates the supply of money and the cost and

availability of credit in the economy. It deals with both the lending and

borrowing rates of interest for commercial banks.

•The Monetary Policy aims to maintain price stability, full employment and

economic growth.

•The Monetary Policy is different from Fiscal Policy as the former brings

about a change in the economy by changing money supply and interest

rate, whereas fiscal policy is a broader tool with the government.

•The Fiscal Policy can be used to overcome recession and control inflation.

It may be defined as a deliberate change in government revenue and

expenditure to influence the level of national output and prices.



•1. BANK RATE OF INTEREST

•2. CASH RESERVE RATIO

•3. STATUTORY LIQUIDITY RATIO

•4. OPEN MARKET OPERATIONS

•5. MARGIN REQUIREMENTS

•6. DEFICIT FINANCING

•7. ISSUE OF NEW CURRENCY

•8. CREDIT CONTROL



• CRR, or cash reserve ratio, refers to a portion of deposits (as cash)

which banks have to keep/maintain with the RBI. During Inflation RBI

increases the CRR due to which commercial banks have to keep a

greater portion of their deposits with the RBI .

• This serves two purposes. It ensures that a portion of bank deposits is

totally risk-free and secondly it enables that RBI control liquidity in the

system, and thereby, inflation.



•Banks are required to invest a portion of their deposits in government

securities as a part of their statutory liquidity ratio (SLR) requirements .

•If SLR increases the lending capacity of commercial banks decreases

thereby regulating the supply of money in the economy.



• It refers to the buying and selling of govt. Securities in the open

market . during inflation RBI sells securities in the open market

which leads to transfer of money to RBI.

•Thus money supply is controlled in the economy.



•During Inflation RBI fixes a high rate of margin on the securities kept by

the public for loans .

•If the margin increases the commercial banks will give less amount of

credit on the securities kept by the public thereby controlling inflation.



•It means printing of new currency notes by Reserve Bank of India .If

more new notes are printed it will increase the supply of money thereby

increasing demand and prices.

•Thus during Inflation, RBI will stop printing new currency notes thereby

controlling inflation.



•During Inflation the RBI will issue new currency

notes replacing many old notes.

•This will reduce the supply of money in the

economy.



1. Increase in Imports of Raw materials

2. Decrease in Exports

3. Increase in Productivity

4. Provision of Subsidies

5. Use of Latest Technology

6. Rational Industrial Policy

inflation and indian policies

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