report on effects of inflation in india

7/28/2019 report on effects of inflation in india

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THESIS REPORT

ON

STUDY OF INFLATION AND ITS EFFECTS

AS PART PGDM PROGRAM

SUBMITTED BY

Abul Basar Mullick

DM11MF02

SUBMITTED TO

IAEERS PUNE INSTITUTE OF BUSINESS MANAGEMENT

(APPROVED BY AICTE, MINISTRY OF HRD, GOVT. OF INDIA)

PUNE

2011-2013


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ACKNOWLEDGEMENT

This report has been an honest and dedicated attempt to make the analysis on marketing material as

authentic as it could. And I earnestly hope that it provides useful and workable information and knowledge

to any person reading it.

I express my sincere thank to my thesis report guide and my institute faculties for guiding me.

Lastly I am grateful to my parents who been my mentor and motivation I am also thankful to all my batch

mates who have been directly or indirectly involved in successful completion of this thesis report.


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TABLE OF CONTENT

Chapter no. Topic Page no

1 IntroductionBackground of the study

Statement of the Problem

Objectives of the Study

Hypotheses of the Study

Significance of the Study

Scope and Limitations of the Study

Definition of Terms

4

5

6

7

7

7

8

8

2

Review of Related Literature 9-13

3 Features of InflationTypes of Inflation

Some advantages of planned inflation?

Causes of Inflation

Measurement of Inflation in India

Economic Effects of Inflation

How to control Inflation?

Why is RBI unable to control inflation?The Relationship between Interest and Inflation

What Is the Relationship between GDP and Inflation?

14-15

16-19

20

21-24

25-27

28-29

30-32

3334

35

4 Methodology 36-37

5

Research Report

Survey on Inflation in India

38-41

41-42

6 SummeryConclusion

Recommendations

Bibliography

Appendix : Inflation rate, GDP Rate, Repo Rate, Reverse

Repo Rate, CRR Rate and SLR Rate in India

43-44

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46

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CHAPTER- 1.IntroductionInflation means a considerable and persistent rise in the general price of goods and services over a period of

time. It indicates the percentage rise in the general prices today compare to a year ago. The rise (fall) in

inflation means that purchasing power of money declines (increases).

A continuous rise in the general price level over a long period of time has been the most common feature of

both developed and developing economies. India, a fast developing nation is facing a high rate of inflation

which has created economic, social, and political problems of the country. It is the stage of too much money

chasing too few goods. It is perhaps the second most serious macroeconomic problem confronting the world

economy today. This problem has claimed more attention of the economists, policy makers and politicians.

The prices of commodities will, over time, rise and fall, responding to the pulls and pushes of demand and

supply. These price movements are natures way of signaling to consumers that they should c onsume less of

the commodity facing shortage and more of the commodity in glut and to producers to produce more of what

is in short supply and less of what is available in plenty. For the common person, there is something

threatening about the phenomenon of inflation, especially on those occasions when the rise in prices ofgoods is not matched by an equivalent increase in the prices of labour. Consequently, inflation also reflects

erosion in the purchasing power of money- a loss of real value in the internal medium of exchange and unit

of account in the economy. The effects of inflation are not distributed evenly in the economy, and as a

consequence there are hidden costs to some and benefits to others from this decrease in the purchasing

power of money. (Later termed monetary inflation) has on the price of goods (later termed price inflation,

and eventually just inflation).
http://en.wikipedia.org/wiki/Monetary_inflationhttp://en.wikipedia.org/wiki/Monetary_inflation


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Background of the Study

Rapid growth in developing countries, and especially in China and India, has led to an important decline in

poverty both at the national level and, due to the large size of China and India, at the global level as well.

However, in many emerging markets income inequality has risen as more open and market-oriented

economies have increased profits and potential wages, particularly for skilled labor. At the same time, rapid

growth has pushed up commodity prices around the globe, raising questions about whether a seemingly

inexorable rise in food prices is aggravating the problems faced by the poor around the world. While

inflation is often seen as aggravating poverty and worsening the income distribution, distinguishing between

food and nonfood inflation could be of merit. Higher food prices can hurt the wellbeing of many poor

people, particularly in urban areas, but may benefit producers, reducing poverty among some in rural areas

households can hedge by allocating their portfolios between cash, which rapidly loses value, and

consumption for goods, which may lose value less quickly. Middle income households confronted with

rising inflation might thus bring forward purchases of clothing, appliances, house wares, or other products in

their consumption basket. But the consumption basket of poor households is disproportionately focused on

food, which due to perish ability, cannot really be brought forward.Finally, at the domestic level, if wages in rural areas are relatively elastic to food prices, then higher food

inflation will improve or at least not worsen income inequality in rural areas, while its effect in urban areas

is likely to be, as with nonfood inflation, negative. These effects can be studied more closely in the case of

India, where richer sub national data are available. India estimates income inequality for both urban and

rural areas across the various states. CPI data are estimated at the state level of rural areas within each state,

and proxies can be calculated for urban areas. Using these data, we can separately assess the impact of food

and nonfood inflation on both rural and urban income inequality. Nonfood inflation should lead to

worsening income inequality in both regions, and food inflation in urban areas should also result in

worsening income inequality. But if wages in rural areas react elastically to increases in food prices, thenhigher food inflation should lead to a decline in income inequality in rural areas.


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Statement of the Problem

Inflation, can our economy grow without it? What is inflation? The definition of inflation is an abnormal

increase unavailable currency and credit beyond the proportion of available goods. Although, Websters is

considered by most to be the overall best dictionary, Word Net states the meaning of inflation a lot clearer

by saying, its a general andprogressive increase in prices. It occurs when the value of goods rises faster

than the value of money. The usual approximate measure of this is the Consumer Price Index, which weigh

the prices of different goods according to importance in a typical budget and then shows how much the

prices of these goods have increased. This immediately raises some problems; for example, the weight of the

goods must change over time. The importance of computers was not measured in the price index 100 years

ago. Another problem is the failure of the price index to capture changes inequality. The quality of a good

may have improved by 20%, while the price has only risen by 10%. The consumer price index doesnt feel

this should be a factor, but many would disagree. Hence, inflation is not easy to define in practice. This

should be kept in mind when discussing how to defeat inflation. There have been numerous theories on

how to defeat inflation and even some theories on whether, or not, it should be defeated at all. Some say

that inflation is not only expected, but also often, needed. Economists believe that in order for the economyto expand and grow, there has to be some level of inflation. Therefore, the opposite holds true as well. If you

want to lower inflation, you have to accept a semi-standard economy. They call this tradeoff the Phillips

Curve. The Phillips Curve is thought to be the proper way of balancing economic growth and inflation.

For this reason the Federal Reserve is always looking for the perfect equilibrium at which we can maximize

our economic growth while keeping inflation as minimal as possible. They do this by increasing and

decreasing interest rates. Although, Economists and the Federal Reserve abide by the Phillips Curve as a

general rule for not letting inflation get out of hand, it has been proven many times in the past that it

is possible to have a very healthy and prosperous economy without raising inflation at all. There are even

examples of inflation declining while the economy booms. As Steve Forbes, of Forbes magazine, said,Prosperity is not the fuller of inflation. For example, in the 1980's, when the economy was at a major high,

inflation fell from 13% all the way to 4%. Thats an incredible drop for such a short period of time.


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Objectives of the Study

To analyze the effect of rate of interest on inflation in India.

To know how inflation is calculated in India?

To know how India controls Inflation & rationale behind the control measures?

To know the relationship between Inflation & GDP growth rate.

To know what are the type of Inflation?

To know what are the cause for inflation in India?

To know what are the effect of inflation in India?

To know why Indian Govt. fail to control on inflation?

To know current scenario of Inflation in India. (Current Data on Inflation).

Hypotheses of the Study

The hypotheses to be tested in the course of this study are stated below:Hypothesis I

Ho: Inflation does not affect significantly the economic growth of India.

H1: Inflation affects significantly the economic growth of India.

Hypothesis II

Ho: Inflation does not affect significantly capital formation in India.

H1: Inflation affects significantly capital formation in India.

Hypothesis III

Ho: there is no significant relationship between inflation and consumption expenditure of people in India.

H1: there is relationship significant between inflation and consumption expenditure of people in India.

Significance of the StudyA vital component of any move towards macroeconomic stability and growth is an integrated effort towards

price stability. In order to identify the macroeconomic effect of inflation persistence in India, this study

would investigate the impact of inflation on macroeconomic variables such as productivity, investment, and

consumption.

This study is significant in the followings ways:

a. it would have a direct effect on the efficiency and effectiveness of the use of policy instruments in the

stabilization of macroeconomic variables to stimulate production and investment.

b. it would reveal the remote and immediate causes of inflation in India with due consideration to theoretical

foundations.

c. it would also provide an explanation for Indias stunted growth


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Scope and Limitations of the Study

The study based on the secondary data provided by Reserve Bank of India (RBI).

Because of time shortage many related area cant be focused in depth.

Website in different organization of India contains poor information.

Recent data and information on different activities was unavailable.

Definition of Terms

Deflation: Deflation is a condition of falling prices. It is just the opposite of inflation. In deflation, the

value of money goes up and prices fall down. Deflation brings a depression phase of business in the

economy.

Disinflation: Disinflation refers to lowering of prices through anti-inflationary measures without causing

unemployment and reduction in output.

Reflation: Reflation is a situation of rising prices intentionally adopted to ease the depression phase of theeconomy. In reflation, along with rising prices, the employment, output and income also increase until the

economy reaches the stage of full employment.

Stagflation: Paul Samuelson describes Stagflation as the paradox of rising prices with increasing rate of

unemployment.

Stagnation: Stagnation in the rate of economic growth which may be a slow or no economic growth at all.

Statflation: The term 'Statflation' was coined by Dr. P.R. Brahmananda to describe the inflationarysituation of India. According to Brahmananda, Rising prices in the middle of a recession is known as

Statflation


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CHAPTER 2.

REVIEW OF RELATED LITERATURE

Topic: Evaluating Core Inflation Measures for India

Author: Motilal Bicchal, Naresh Kumar Sharma and Bandi Kamaiah

Abstract:This paper discusses in some detail various existing approaches of measuring core inflation,

evaluating their potential advantages and disadvantages. Then a variety of measures of core inflation for

India based on three methods are constructed. Among these measures, three are based on conventional ex-

food and energy principle and one measure that exclude fifteen of most volatile components

are constructed. While constructing exclusion based indices of core inflation; measures are constructed such

that only a small weight remains excluded from the index of the core inflation. The other two

core measures are variations of Neo Edgeworthian Index are constructed by reweighting 69 disaggregated

components series of WPI. Then another class of core measures is computed based on weighted exponential

smoothing which was primarily developed by Cogley (2002). Estimates of core inflation based on their

indices are then calculated for 1995 to 2007 (on monthly basis).

Conclusion: Since the inception of the term core inflation, there is neither a commonly accepted heretical

definition nor an agreed method of measuring it. Because of the fact that it isunobservable, it has to be

estimated. One of the objectives of this paper was to review existing theoretical approaches of measuring

core inflation. We, then, constructed several measures of core inflation for India. Among these measures,

three are based on popular ad hoc exclusion principle and one measure that exclude fifteen of most volatile

components. While constructing exclusion based core indices, we determined that it should be done suchthat small amount of weight is excluded in constructing the core index. The other two core measures, which

are variations of Neo-Edgeworthian Index, were constructed by reweighting 69 disaggregated components

series of WPI. Further, another class of core measures was constructed based on weighted exponential

smoothing which was primarily developed by Cogley (2002).

Topic: Inflation Targeting in India: Issues and Prospects

Author: Raghbendra Jha

Abstract: Inflation targeting (henceforth IT) has emerged as a significant monetary policyframework in

both developed and transition economies. Some authors have argued that for transition economies

undergoing sustained financial liberalization and integration in world financial markets IT is an attractive

monetary policy framework. The present paper evaluates the case for IT in India. It begins by stating the

objectives of monetary policy in India and argues that inflation control cannot be an exclusive concern

of monetary policy with widespread poverty still present. The rationale for IT is then spelt out and found tobe incomplete. The paper provides some evidence on the effects of IT in developed and transition

economies and argues that although IT may have been responsible for maintaining a low inflation regime it


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has not brought down the inflation rate itself substantially. Further, the volatility of exchange rate and output

movements in transition rise adopting IT has been higher than in developed market economies. I then

discuss Indias experience with using rules-based policy measures (nominal targets) and discuss why India is

not ready for IT. I show that even if the Reserve Bank of India (RBI) wanted to, it could not pursue IT since

the short-term interest rate (the principal policy tool used to affect inflation in rise working with IT) does not

have significant effects on the rate of inflation. The paper concludes by listing monetary policy options for

India at the current time.

Conclusion: This paper has argued that the primary objective of Indian monetary policy, at least in the

medium term, has to be the attainment of higher economic growth. Moreover, since India has high inflation

aversion, this objective does not conflict with that of short termstabilization.Monetary policy in India has to

be conducted against this background. This paper has argued that the multi-objective formulation pursued

by the RBI has merit and that such monetary policy should be pursued to maintain stable interest and

inflation rates and as lightly undervalued currency in order to engineer higher export led growth. A second

policy measure is weighted towards real exchange rate appreciation (more in line with IT) and would

involve relatively larger current ac deficits. Real appreciation, intern, could be secured by nominalappreciation or by permitting higher inflation. Both policies would lead to low inflation rates and reduced

inflows of foreign capital and, therefore, lower accumulation of reserves at given rates of sterilization.

Policy packages that use import liberalization would, like real appreciation, permit higher absorption via

higher current ac deficits but without penalizing exports. The optimal package for India is a judicious

combination of these two broad sets of policies with greater emphasis on fiscal consolidation and import

liberalization, rather than real exchange rate appreciation via nominal appreciation or inflation. These are

essential elements of an appropriate monetary policy regime for India.

Topic: Inflation Determination with Taylor Rules: A Critical Review

Author: John H. Cochrane

Abstract: The new-Keynesian, Taylor-rule theory of inflation determination relies on explosive dynamics.

By raising interest rates in response to inflation, the Fed does not directly stabilize future inflation. Rather,

the Fed threatens hyperinflation or deflation, unless inflation jumps to one particular value on each date.However, there is nothing in economics to rule out hyperinflationary or deflationary solutions. Therefore,

inflation isjust as indeterminate under active interest rate targets as it is under standard fixed interest rate

targets. Inflation determination requires ingredients beyond an interest-rate policy that follows the Taylor

principle.

Conclusion: Practically all verbal explanations for the wisdom of the Taylor principle the Fed should

increase interest rates more than one for one with inflation use old-Keynesian, stabilizing, logic: This

action will raise real interest rates, which will dampen demand, which will lower future inflation. New-

Keynesian models operate in an entirely different manner: by raising interest rates in response to inflation,

the Fed threatens hyperinflation or deflation, or at a minimum a large non-local movement, unless

inflation jumps tone particular value.


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Topic: inflation theory: a critical Literature review and a new Research agenda

Author: Alfredo Saad-Filho

Abstract:Marxian analyses of inflation tend to fall under three broad categories, those thatemphasize

primarily the role distributive conflicts, monopoly power, or state intervention on the dynamics of credit

money. This article reviews these interpretations, and indicate show they can be integrated. The proposed

approach, based on the 'extra money' view, departs from the circuit of capital and the endogeneity of credit

money in order to explain inflation in inconvertible paper money systems.

Conclusion: This article has analyzed critically the three best known Marxian theories of inflation. They

argue, in different ways, that inflation is a historically specific phenomenon, but its form can be abstractly

determined from the broad features of modem capitalism. However, beyond a certain point concrete studies

become necessary in order to contextualize the analysis. Different alternatives are proposed in order to

overcome the difficult dilemmas imposed by the attempt to explain inflation in inconvertible money

systems, while preserving the endogeneity and non-neutrality of money. They are also heavily dependent onthe context of the analysis.

Topic: exchange rate regimes and inflationOnly hard pegs make a difference

Author: Michael Bleaney and Manuela Francisco

Abstract: Previous research has suggested that pegged exchange rates are associated with lower inflation

than floating rates. In which direction does the causality run? Using data from a large sample of developing

rise from 1984 to 2000, we confirm that hard pegs (currency boards or a shared currency) reduce inflation

and money growth. There is no evidence that soft pegs confer any monetary discipline. The choice

between soft pegs and floats is determined by inflation: when inflation is low, pegs tend to be chosen and

sustained, and when inflation is high, either floats are chosen or there are frequent regime switches.

Conclusion: The theoretical analysis suggested that pegs would be associated with lower inflation than

floats, provided that the costs of devaluation were significant. Whether the costs of devaluation represent a

major deterrent to inflation in any given form of peg is an empirical question. In our empirical work we

distinguish hard pegs (a shared currency or a currency board) from other forms of peg (soft pegs), on the

grounds that the obstacles or disincentives to devaluation are much higher for hard pegs.

Topic: Inflation and Growth: In Search of a Stable Relationship

Author: Michael Bruno and William Easterly


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Abstract: Are inflation and growth inversely associated, directly associated, or not associated? Is the

empirical inflation growth relationship primarily a long-run relationship across rise, a short run relationship

across time, or both? Like a bickering couple, inflation and growth just cannot seem to decide what their

relationship should be.

Conclusion: The early empirical literature on inflation and growth found little in the way of relationship

between the two. The growth literature detected a relationship between inflation and growth only after rise

kindly provided some discrete high inflation crises in the 1980s. And even then it was still unclear whether

there was a long-run or a short-run relationship because the empirical relationships were weak with long-

period averages and strong with short-period averages. Despite extensive counseling by the new growth

literature, the indecisive couple of inflation and growth cannot decide whether they belong together in the

short run or in the long run.

Other Literature Review

The seminal work by Fischer (1993) is among the first to examine the possibility of non-linearities in the

relationship between economic growth and inflation in the long run. Using both cross section and panel data

for a sample that includes developing and industrialized countries, Fischer's parameter estimates indicate a

negative relationship between inflation and growth. Subsequently, many empirical studies on inflation

threshold used a large panel data across countries. Sarel (1996) used annual data from 1970 to1990 for 87

countries and found that the threshold is at 8 per cent below which the effect of inflation on growth isnegligible (or slightly positive) but beyond 8 there is a significant, extremely powerful and robust negative

effect on economic growth. On similar lines, Ghosh and Phillips (1998) used a large panel data set, covering

IMF member countries over 196096. Their results suggest a negative relationship between inflation and

growth that is both statistically and economically significant. The relationship is non-linear in two senses:

first, at very low inflation rates, the relationship is positive; second, at all other inflation rates, the apparent

marginal effect of inflation on growth becomes less important as higher inflation rates are considered.

Analysis of Khan and Senhadji (2001) using a dataset including 140 countries (comprising both industrial

and developing countries) for a period 1960 to 1998 revealed that the threshold level of inflation above

which it significantly slows growth is estimated at 13 per cent for industrial countries and 1112 per cent

for developing countries. Drukker, Gomis- Porqueras, and Hernandez-Verme (2005) confirmed the

existence of a threshold using a panel of 138 countries, but they estimated its level to be higher, at about 19

per cent. This level of threshold, higher than usually estimated, was confirmed by Pollin and Zhu (2006)

who also divided the sample by decades and suggested that threshold would be around 15-18 per cent. A

much lower threshold was obtained by Burdekin et al. (2004), who estimated a panel model of 72 countries

using annual data and, allowing for multiple thresholds, found that for developing countries, inflation proves

to be costly when it is higher than 3 per cent. A second break was also identified at 50 per cent, above which

marginal growth costs declines significantly. Espinoza et al. (2010) used a panel of 165 countries and for a

period 19602007. They estimated a threshold of about 10 per cent for all country groups (except for


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advanced countries) above which inflation quickly becomes harmful to growth. However, for the advanced

economies, threshold was much lower.

Many studies in Indian context have provided differing views on inflation threshold. Chakarvarty

Committee (1985) referred to it as the acceptable rise in prices at 4 per cent. This, according to the

Committee, reflects changes in relative prices necessary to attract resources to growth sectors. As growth is

not uniform in all the sectors, maintaining absolute price stability, meaning a zero rate of increase in prices,may not be possible and nor is it desirable. Rangarajan (1998), who pioneered the concept of threshold

inflation, brought central bank focus on inflation rate at 67 per cent known as acceptable level of

inflation. His idea of threshold was: at what level of inflation do adverse consequences set in? The study by

Vasudevan et al. (1998) and, Kannan and Joshi (1998) found the threshold level to be around 6 per cent.

Results of Samantaraya and Prasad (2001) are also on similar line as they found the threshold level to be

around 6.5 per cent. In contrast, Singh and Kalirajan (2003) using annual data for the period of 19711998

provided argument against any threshold level for India. A more recent study by Singh (2010) which used

both, yearly and quarterly data, found threshold level of inflation for India at 6 per cent but failed to confirm

the same in Sarel (1996) sense.


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CHAPTER 3.

THEORETICAL/CONCEPTUAL/OPERATIONAL FRAMEWORK

FEATURES OF INFLATION:

Following are the main features of inflation:

1. The phenomenon is not to be equated with the fact of high prices. It is a phenomenon of rising prices. It is

a continuous fall in the purchasing power of money in absolute terms.

2. In an economy which uses money and credit and which operates under the guidance of market

mechanism, some adjustment of individual prices is always going on in response to the dynamism of

changing demand and supply forces. In other words, in such an economy, a continuous shift is taking place

in relative prices. However, inflationary process is not the adjustment of individual prices, or relative prices.It is a process of continuous price rise in absolute terms, that is, a process of continuous fall in the

purchasing power of money. The phenomenon of price rise is not restricted to only selected items. Its

coverage keeps increasing and more and more prices start rising.

3. There is no absolute rate of price rise, which can be said to demarcate between inflationary and non-

inflationary situations. This is because, by its very nature, an inflationary process is a continuous and

cumulative one. Having started once, the rate of price rise keeps gathering momentum and is bound to

exceed any prescribed rate. Unless we are able to check it through some means, the rate of price rise

becomes so high that it leads to the collapse of the entire monetary system of the country.

4. As we have noted before, in a market economy, several individual prices are always under a process of

adjustment in response to forces of demand and supply forces. In addition, there is a close input-output

relationship between different categories of economic activities. In other words, when one price changes,

there is generally an increase in input cost of several other economic activities which in turn leads to further

price rise. The result is that it is possible for any individual price rise to become a cause for an inflationary

process. We cannot keep an eye on only some selected prices and be sure that inflationary process would not

start.

5. On account of input-output relations between different industries, inflationary process keeps increasing its

coverage. With the passage of time, more and more prices are engulfed by it. It also leads to an increasing

rate of price rise. It becomes a self-feeding cumulative process.

6. On account of close interaction between industries, we do not have any predetermined set of causes and

'effects' of inflation. A given macro-variable alternatively becomes its cause and effect. For example, an

increase in wage rate can result in an increase in production costs. Higher production costs can become the

cause of higher prices, which in turn can become the cause of further rise in wages.

7. Higher prices necessitate a greater need for means of payment in the form of currency and credit. The

authorities also require more funds to finance their activities. As a result, they increase the supply of

currency. And at the same time, there is a greater generation of credit in the economy. However, increasing

supply of money and credit helps in pushing prices further up, leading to the need for still additional supply


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of money and credit. Thus, a continuous increase in the supply of money and credit becomes an essential

feature of inflation.

8. When inflationary process gains strength, it gives rise to expectations of further price rise. This increases

the speed with which people spend their money balances.

9. When expectations of price rise become widespread, the suppliers develops tendency to hold backsupplies, pile up stocks and create an artificial scarcity. They find that to hold back existing supplies is

becoming increasingly more profitable than to produce fresh.

10. Price expectations also alter the asset preferences of the community. People prefer to hold more of non-

monetary assets, which are expected to retain their 'real' purchasing power as against nominal money

balances, which are continuously losing their purchasing power.

11. In the initial stages, there is an increase in interest rate because the lenders want to be compensated for

the loss in the purchasing power of their loans. In later stages, however, money starts losing value so fast

that the entire financial system may be disrupted and eventually collapses.

12. In the initial stages of inflation, the economy registers a growth in the output and employment along with

an increase in prices. That is to say, rising prices provide an incentive to investors and producers in the form

of higher expected profit. They are ready to invest more even in the face of rising rate of interest. However,

in later stages of inflation.

(i) The phenomenon of increasing costs

(ii) Expectations of further rice rise

(iii) Other factors lead to afallin real output and prices while there is an exponential growth in the supply of

money.

13. Right from the beginning, there is a growing inequality in income distribution. Contractual incomes

{like wages, interest, rent, etc.) lag behind while non- contractual and for residual incomes (like profit)

increase in both absolute terms and as a proportion of the national income.

14. Inflation is the result of market imperfections. If the demand and supply flows are able to adjust

themselves to changing prices without time lags, a persistent price rise cannot take place and inflationary

process cannot come into existence.


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Types of Inflation

1. Types of inflation on the basis of coverage and scope point of view:-Comprehensive Inflation: When the prices of all commodities rise throughout the economy it is known as

Comprehensive Inflation. Another name for comprehensive inflation is Economy Wide Inflation.

Sporadic Inflation: When prices of only few commodities in few regions (areas) rise, it is known as Sporadic

Inflation. It is sectional in nature. For example, rise in food prices due to bad monsoon (winds bringing

seasonal rains in India).

2. Types of Inflation on Time of Occurrence

War-Time Inflation: Inflation that takes place during the period of a war-like situation is known as War-Time inflation. During a war, scare productive resources are all diverted and prioritized to produce military

goods and equipments. This overall result in very limited supply or extreme shortage (low availability) of

resources (raw materials) to produce essential commodities. Production and supply of basic goods slow

down and can no longer meet the soaring demand from people. Consequently, prices of essential goods keep

on rising in the market resulting in War-Time Inflation.

Post-War Inflation: Inflation that takes place soon after a war is known as Post-War Inflation. After the

war, government controls are relaxed, resulting in a faster hike in prices than what experienced during the

war.

Peace-Time Inflation: When prices rise during a normal period of peace, it is known as Peace-Time

Inflation. It is due to huge government expenditure or spending on capital projects of a long gestation

(development) period.

3. Types of Inflation on Government Reaction

Open Inflation: When government does not attempt to restrict inflation, it is known as Open Inflation. In afree market economy, where prices are allowed to take its own course, open inflation occurs.

Suppressed Inflation: When government prevents price rise through price controls, rationing, etc., it is

known as Suppressed Inflation. It is also referred as Repressed Inflation. However, when government

controls are removed, Suppressed inflation becomes Open Inflation. Suppressed Inflation leads to

corruption, black marketing, artificial scarcity, etc.


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4. Types of Inflation on Rising Prices

Creeping Inflation: When prices are gently rising, it is referred as Creeping Inflation. It is the mildest

form of inflation and also known as a Mild Inflation or Low Inflation. According to R.P. Kent, when prices

rise by not more than (up to) 3% per annum (year), it is called Creeping Inflation.

Chronic Inflation: If creeping inflation persist (continues to increase) for a longer period of time then it is

often called as Chronic or Secular Inflation. Chronic Creeping Inflation can be either Continuous (which

remains consistent without any downward movement) or Intermittent (which occurs at regular intervals). It

is called chronic because if an inflation rate continues to grow for a longer period without any downturn,

then it possibly leads to Hyperinflation.

Walking Inflation: When the rate of rising prices is more than the Creeping Inflation, it is known as

Walking Inflation. When prices rise by more than 3% but less than 10% per annum (i.e. between 3% and

10% per annum), it is called as Walking Inflation. According to some economists, walking inflation must be

taken seriously as it gives a cautionary signal for the occurrence of running inflation. Furthermore, ifwalking inflation is not checked in due time it can eventually result in Galloping inflation.

Moderate Inflation: Prof. Samuelson clubbed together concept of Crepping and Walking inflation into

Moderate Inflation. When prices rise by less than 10% per annum (single digit inflation rate), it is known as

Moderate Inflation. According to Prof. Samuelson, it is a stable inflation and not a serious economic

problem.

Running Inflation: A rapid acceleration in the rate of rising prices is referred as Running Inflation. When

prices rise by more than 10% per annum, running inflation occurs. Though economists have not suggested afixed range for measuring running inflation, we may consider price rise between 10% to 20% per annum

(double digit inflation rate) as a running inflation.

Galloping Inflation: According to Prof. Samuelson, if prices rise by double or triple digit inflation rates

like 30% or 400% or 999% per annum, then the situation can be termed as Galloping Inflation. When prices

rise by more than 20% but less than 1000% per annum (i.e. between 20% to 1000% per annum), galloping

inflation occurs. It is also referred as jumping inflation. India has been witnessing galloping inflation since

the second five year plan period.

Hyperinflation: Hyperinflation refers to a situation where the prices rise at an alarming high rate. The

prices rise so fast that it becomes very difficult to measure its magnitude. However, in quantitative terms,

when prices rise above 1000% per annum (quadruple or four digit inflation rate), it is termed as

Hyperinflation. During a worst case scenario of hyperinflation, value of national currency (money) of an

affected country reduces almost to zero. Paper money becomes worthless and people start trading either in

gold and silver or sometimes even use the old barter system of commerce. Two worst examples of

hyperinflation recorded in world history are of those experienced by Hungary in year 1946 and Zimbabwe

during 2004-2009 under Robert Mugabe's regime.


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5. Types of Inflation on Causes

Deficit Inflation: Deficit inflation takes place due to deficit financing.

Credit Inflation: Credit inflation takes place due to excessive bank credit or money supply in the economy.

Scarcity Inflation: Scarcity inflation occurs due to hoarding. Hoarding is an excess accumulation of basiccommodities by unscrupulous traders and black marketers. It is practiced to create an artificial shortage of

essential goods like food grains, kerosene, etc. with an intension to sell them only at higher prices to make

huge profits during scarcity inflation. Though hoarding is an unfair trade practice and a punishable criminal

offence still some crooked merchants often get themselves engaged in it.

Profit Inflation: When entrepreneurs are interested in boosting their profit margins, prices rise.

Pricing Power Inflation: It is often referred as Administered Price inflation. It occurs when industries and

business houses increase the price of their goods and services with an objective to boost their profit margins.

It does not occur during a financial crisis and economic depression, and is not seen when there is a downturn

in the economy. As Oligopolies have the ability to set prices of their goods and services it is also called as

Oligopolistic Inflation.

Tax Inflation: Due to rise in indirect taxes, sellers charge high price to the consumers.

Wage Inflation: If the rise in wages in not accompanied by a rise in output, prices rise.

Build-In Inflation: Vicious cycle of Build-in inflation is induced by adaptive expectations of workers or

employees who try to keep their wages or salaries high in anticipation of inflation. Employers andOrganizations raise the prices of their respective goods and services in anticipation of the workers or

employees' demands. This overall builds a vicious cycle of rising wages followed by an increase in general

prices of commodities. This cycle, if continues, keeps on accumulating inflation at each round turn and

thereby results into what is called as Build-in inflation.

Development Inflation: During the process of development of economy, incomes increases, causing an

increase in demand and rise in prices.

Fiscal Inflation: It occurs due to excess government expenditure or spending when there is a budget deficit.

Population Inflation: Prices rise due to a rapid increase in population.

Foreign Trade Induced Inflation: It is divided into two categories, viz., (a) Export-Boom Inflation, and (b)

Import Price-Hike Inflation.

Export-Boom Inflation: Considerable increase in exports may cause a shortage at home (within exporting

country) and results in price rise (within exporting country). This is known as Export-Boom Inflation.

Import Price-Hike Inflation: If a country imports goods from a foreign country, and the prices of importedgoods increases due to inflation abroad, then the prices of domestic products using imported goods also

rises. This is known as Import Price-Hike Inflation. For e.g. India imports oil from Iran at $100 per barrel.


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Oil prices in the international market suddenly increases to $150 per barrel. Now India to continue its oil

imports from Iran has to pay $50 more per barrel to get the same amount of crude oil. When the imported

expensive oil reaches India, the Indian consumers also have to pay more and bear the economic burden.

Manufacturing and transportation costs also increase due to hike in oil prices. This, consequently, results in

a rise in the prices of domestic goods being manufactured and transported. It is the end-consumer in India,

who finally pays and experiences the ultimate pinch of Import Price-Hike Inflation. If the oil prices in the

international market fall down then the import price-hike inflation also slows down, and vice-versa.

Sectoral Inflation: It occurs when there is a rise in the prices of goods and services produced by certain

sector of the industries. For instance, if prices of crude oil increase then it will also affect all other sectors

(like aviation, road transportation, etc.) which are directly related to the oil industry. For e.g. If oil prices are

hiked, air ticket fares and road transportation cost will increase.

Demand-Pull Inflation : Inflation which arises due to various factors like rising income, exploding

population, etc., leads to aggregate demand and exceeds aggregate supply, and tends to raise prices of goods

and services. This is known as Demand-Pull or Excess Demand Inflation.

Cost-Push Inflation: When prices rise due to growing cost of production of goods and services, it is known

as Cost-Push (Supply-side) Inflation. For e.g. If wages of workers are raised then the unit cost of production

also increases. As a result, the prices of end-products or end-services being produced and supplied are

consequently hiked.

6. Types of Inflation on Expectation

Anticipated Inflation: If the rate of inflation corresponds to what the majority of people are expecting or

predicting, then is called Anticipated Inflation. It is also referred as Expected Inflation.

Unanticipated Inflation: If the rate of inflation corresponds to what the majority of people are not expecting

or predicting, then is called Unanticipated Inflation. It is also referred as Unexpected Inflation.


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Some advantages of planned inflation?

The revenue generated by government in the form of income tax, property tax etc will see a massivejump with inflation making things costlier for the consumer.

Though inflation is existing for the common people but for government knows that this is onlyvirtual and their spending will always lag the accumulated funds creating a reserve surplus. This

proves very effective for those governments who are facing huge debt problems. The extra cash

reserves can be used to pay a portion of the debts.

With Inflation rate rising in the economy, not only the purchasing power of common man reducesbut it also reduces the purchasing power of foreign government who holds your currency. In case of

inflation they are also under pressure to spend their held currency on goods and services.

The best investment for inflation hedge is to buy a property. In US due to current economic crisis alot of property has remained unsold for long time. In case investors see that inflation is creeping in,they start buying property as an inflation hedge. This will further push spending on real estate

projects.

Inflation can also make a economic growth of a country look handsome. How? For people who haveinvested in those good old days and find their valuation dropping each day will start seeing signs of

growth due to value appreciation on account of planned inflation. Moreover people will also would

like to step up their investment gear as they would know that due to inflation the same thing is going

to prove more costly for their in future.

Under pressure of inflation the industrial product become costlier. This will directly influence theturnover of companies for good. With top of line of the company increasing the share market is sure

to revive in course of time. Investors will start pumping there in the market. Basically the money will

start flowing in.

Inflation has always made the richer more rich and poor feebler. As rich has cash reserves that allowsthem to invest their money earlier to take advantage of inflation in future. But poor does not have

this advantage of extra cash (for investment) and continues to get poorer. In other words rich get

richer and poor get poorer.


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Causes of Inflation

An increase in the general level of prices implies a decrease in the purchasing power of the currency. This

problem is not too serious. What matters is not how fast and how long the price level must rise before the

rise is called inflationary but what causes the price level to rise in the first place and what are the

consequences of different rates of price level change for the distribution of income

High Demand: If the demand for a commodity is much above than the supply, the price of the

commodity would increase. It is so happened in 2010 that a decrease in sugarcane production led to

decreased production of refined sugar causing its prices to rise in the open market. This kind of inflation is

called demand pull inflation.

Supply led Inflation: The recent rise in rubber, iron, and steel prices have led to an increase in the

production cost of automobiles with the consequence that their prices have been hiked by the manufactures.

The inflation caused by such a price is called cost push inflation.

Black Marketing: When a particular type of commodity has stocked by a wholesaler and sell in the time

of scarcity of the commodity then it increase the price not only of that commodity but also those which

manufactured by the stocked commodity. For example if sugar is stocked by the wholesalers this create the

scarcity of the sugar in the market and when demand of sugar reach on peak then it releases on the high

prices, the prices of sweets will also go high.

Increase in Purchasing Capacity of Consumer: If some where a retailer increased the price of

commodity for its own profit and more than 50% consumers of the city do not object of this means the 50%

consumers have the capacity to purchase that commodity and this will led the inflation.

Interest Rate on Loan given to the Manufacturer by the Banks:When the rate of interest is

increased on the corporate loan the input cost of the manufactured commodity will increased so the cost of

finished goods in the market will increased.

Interest Rate on Saving: When the interest rate on savings decreases the common man do not want to

put their money into the banks and so the money will automatically flow towards the market and this will

contribute to the inflation.

International fuel Prices: The country like India is highly dependent on the import of crude oil. It

imports more than 70% crude oil from the countries like Iran, and other Arab countries. This crude oil is

refined and then converted into petroleum products like petrol, diesel, cooking gas, CNG, kerosene oil, and

many more. These fuels are running our houses as well as our transportation system. So, if the price of crude

oil fluctuates in international market then in that consequence the prices of all commodities will get affected.

Foreign Exchange Rate: Recently the value of Rupee has depreciated against US Dollar. This

fluctuation in the price of rupee against dollar contributes highly to inflation. We are not independent of the

crude oil generation and we purchase the crude oil from other countries. To make this deal we have to pay

the dollar for an international deal and to purchase dollar we have pay more amount in Rupees if the price of


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a dollar is high. Interest rate on loan taken from other countries and IMF will become more costly. It simply

means the import becomes costly and interest paid on the debt taken contributes to inflation.

Lack of agricultural outputPoor performance in the agricultural and its allied activities continue to be a big worry for the Indian

economy, too. This sector has been a worrying one, because it has been failing to meet the total domesticdemand and or failing to generate anticipated GDP contributions. The share of this sector towards the GDP

is a meager one, which has been normally under 15% for the past few financial years. Well, sometimes

many economists, advisers, etc recommend investing in more money, efforts, energy, etc into the agriculture

sector when there is a forecast on inflation in the FY, is a good notion. But even after supplying economic

loans and other facilities to farmers, the predicament of unarguable aggregate output continues to stay active

in India every year. And thus, with the population on the rise, the producers are left with only one option,

which is to hike the final prices of the essential commodities, which are in short supplies. And this is what

exactly been again happening in the economy these days, too. Here, arises one key question: why on earth

the slowdown is on and on in the agricultural production? The following are the scientific reasons for that:

1. Climate change.2. Usage of old tech and methods are on or underway.3. Lack of reliance on new tech.4. Lack economic planning and executions made by farmers and other concerned in the agriculture field,

too.

5. Lack of finance, etc.Weak INR

Weak Indian Rupee is another cause for inflation here in India. She, imports more than exports, owing to a

lot of monetary reasons which also contribute towards a fall in the value of the INR. The national currencyplays a vital role in determining the final value of goods and services that have been imported. Since most

currencies in the globe are subject to twist, the INR is also not spared. Thus, at the international market, in

case the value of INR slides, the final costs would be higher indeed. In India, around 676 commodities are

chosen to calculate inflation figures on Thursdays.

Since, India is not independent entirely, it has to import some essential commodities to make sure the

economic and non economic activities run properly in the economy. Thus, the INR is a key thing which also

determines the final prices of goods and services imported. The buying capacity of INR is sliding at the

foreign market and thus, the final prices have been increasing which mean inflated goods. The INR has

fallen more than a 10% this financial year, 2011, against the greenback.How exactly the fall in the INRs value affects the final prices in India? This can explained with the aid of

the following explicit example:

Let us assume, the current value of the dollar in terms of the INR is 45. The cost of 1barrel of crude oil is 2

dollars. Then, suppose, India decides to buy 1 barrel of the oil, then India pays 90 rupees. Assume on the

next day, the INR falls by a 15% due to some economic reasons (embodying other sorts of reasons), under

such an economic state, 1 dollars value in the INR would stand at 51.75 which mean more rupees to be

spent to buy the same amount of oil. Thus, the final price of 1 barrel of oil imported would be at 103.50

rupees. This, this hike adds up the final general level of prices leading to inflation.


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Causes for fall in the INR value are as under:

1. Investors pull out their investments from the economy to invest in other economies due to economic andnon-economic reasons. By such economic activity of investors, it leads to a fall in the demand for INR,

which ultimately results in the fall of the INRs value, too.

2. Political disturbances in the country also reduce the demand for the INR.3. Other economic issues such as a high rate of inflation also bring down the value of the INR.4. Stability and insurance of returns on investments assured in other parts of the global economy.5. Deliberate depreciation by the central bank, etc.High economic growth (EG)Would high economic growth lead to inflation? Technically speaking, yes but not always (meaning it is

banked on economic and non-economic factors), economic growth would lead to inflation. Myperspective

is, imbalance or balance (33.3% each sector) contributions by the economic sectors towards the GDP, with

or without an increasing trend of a nations population, & or increasing buying capacity leading to demand

for foreign goods because the nation failing to produce all the basic or essential goods and or comfort /

luxurious products in the country, would lead to inflation.A British economist called, David Henderson, also believes that economic growth would lead to inflation. In

a bid to trust the first line of this paragraph about the British economist.

India is the 10th largest economy on this planet behind Japan, Germany, Brazil, China and the USA, etc.

The economic growth has been heading to north each and every financial year in India, normally,

projecting more than a 6% a year. Economic growth is what every productive person wishes

for. But an imbalance in the contributions made by the economic sectors in the economy also give

a feasible room for inflation. Even if there exists a balance in contribution, that is, 33.3% by each sector,

inflation factor would still emerge or rise (if existing) in the economy as no economy on this planet can,

strictly speaking, produce all the essential or basic goods and other types of commodities and services in itsown economy. That is what has been happening with the Indian economy, too.

The following explicit example is a key one to explain how:

Let us consider an assumption that there has been a 10% growth in the Indian economy in the FY 2011 with

the following contributions made by all the economic sectors:

ECONOMIC SECTORS CONTRIBUTION TO GDP

Primary sector 33%

Secondary sector 30%

Tertiary sector 37%
http://about.me/naveen.kalyanihttp://about.me/naveen.kalyani


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Under the above situation, there is still a scope for inflation in the Indian economy since the Indian economy

is reliant on foreign trade to meet some of the basic goods and services which mean a fall in the INR value

would lead to rise in the value of foreign goods prices making them as inflated goods.

But the truth is the above table is awfully close to an unrealistic situation as such types of contributions are

not doable, in reality. When we take into account the sectoral contributions, we find out that agriculture

sectors share in the GDP is less than 18% in the previous fiscal year (2009-2010). Although, the Indian

economy is able to augment its GDP, it does not mean all the basic goods such as oil, vegetables, etc are

produced in the economy, which is just one of the things to be done, meaning in case enough such products

are made, other factors such transportation costs, infrastructure, natural calamities, etc also play a key role in

determining their prices before they are sold in markets. Thus, we learn from this article that, India in order

to meet its basic requirements, it buys some basic goods which is a result of an increase in buying capacity

of the economy due to the augmentation in the GDP value, from overseas at inflated prices, sometimes, and

as the INRs value is subject to change, inflated products are also bought in to the economy for meeting

endogenous demand. Hence proved, economic growth would lead to inflation in any economy.

Population on the riseThe Indian population in the FY 2010 rose at unpalatable rate and still the number is moving to north and

making the total number a disturbing one. The number is on the rise and there has been a no sign of halt.

Some authentic info is as under to back the aforementioned statements pertaining to population.

1. In the year 2001, the Indian population was around 1.01billion.2. In the year 2010-Apr-1, the Indian population was around 1.21billion.In case the population is augmenting and so is the case with the supply of essential commodities

proportionately at palatable prices, then that is called as growth. Issues arise only when the supply of

essential commodities fail to meet the needed demand at agreeable prices. That is what exactly has been

happening in India. Population is a key factor for many economic reasons but it is distracting when it is

more than sufficient and is uncontrolled. It is increasing every day as birth rates have gone up and death

rates have gone down. Since economic producers are unable to meet the demand comfortably, they do not

have any options other than increasing the prices of all concerned economic goods and services and that

results in economic inflation. Thus, an increasing trend in population would lead to inflation.


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Measurement of Inflation in India

Inflation refers to percentage change in the price of a set of goods and services over a period of time. It

represents change in overall price level in the economy. The issue of measurement of Inflation has got a lot

of attention in India. Presently, there are different primary measures of Inflation.

Pt = [(Pt - Pt-1)/Pt-1]* 100

The Inflation rate int over the last one year is given by:

1) GDP Deflator: Growth Domestic Product Deflator refers to the index of the average price of the goods

and services produced in the economy. It is a measure of the level of prices of all new, domestically

produced, final goods and services in an economy. Thus, whether they are produced by foreigners or locals

operating in the country, and bought by local consumers, firms, the government, or even foreigners, all are

included. It ignores the prices of imported goods, which enter our consumption basket and list of inputs in

production. It is calculated as a ratio of Nominal GDP (GDP at current prices) to Real GDP (GDP at

constant prices). It tells us the rise in Nominal GDP that is attributable to a rise in prices rather than a rise in

the quantities produces. The GDP deflator is based on the Paasches Index method of computation. It is

calculated quarterly with a lag of two months since 1996. If the value of price deflator is 500, it means that

the current year price is five times.

2) Wholesale Price Index: This index is the most widely used inflation indicator in India. This is

published by the Office of Economic Adviser, Ministry of Commerce and Industry. WPI captures price

movements in a most comprehensive way. It is widely used by Government, banks, industry and business

circles. Important monetary and fiscal policy changes are linked to WPI movements. It is in use since 1939

and is being published since 1947 regularly. We are well aware that with the changing times, theeconomies too undergo structural changes. Thus, there is a need for revisiting such indices from time to

time and new set of articles / commodities are required to be included based on current economic scenarios.

Thus, since 1939, the base year of WPI has been revised on number of occasions. The current series of

Wholesale Price Index has 2004-05 as the base year. Latest revision of WPI has been done by shifting base

year from 1993-94 to 2004-05 on the recommendations of the Working Group set up with Prof Abhijit Sen,,

Member, Planning Commission as Chairman for revision of WPI series. This new series with base year

2004-05 has been launched on 14th September, 2010.

The Wholesale Price Index refers to the index of the average price of all commodities produced and

transacted in the economy at the wholesale level. WPI is the weighted price index of a basket of goodsconsisting of 435 commodities, which are categorized under three major groups:

1) Primary articles (98 commodities).

2) Fuel power, light and lubricants (19 commodities).

3) Manufactured products (318 commodities).

These three are again divided into smaller subgroups. The WPI series is currently available for the base year

of 1993-94. The weighted arithmetic mean and Laspeyres Index methods are used for the calculation. Th e

series is prepared for the all- India level only. It is available for all commodities as well as for major groups,

sub groups and individual commodities, and is regularly published on a weekly basis by the office of theEconomic Adviser, Ministry of Industries, and Government of India. These features make WPI as an ideal


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measure of the Inflation rate, particularly from the managerial point of view. As the data is available for

different commodity groups, policy makers can easily pin down the source of inflation and then suggest the

policy measures to deal with it. It excludes the prices of all services, such as health, education, banking,

transport and communication. The Indian Government has taken WPI as an indicator of the rate of inflation

in the economy.

3) Consumer Price Index: The CPI measures price change from the perspective of the retail buyer. It is

the real index for the common people. It reflects the actual inflation that is borne by the individual. CPI is

designed to measure changes over time in the level of retail prices of selected goods and services on which

consumers of a defined group spend their incomesConsumer Price Index is measured on the basis of the change in retail prices of a specified set of goods and

services on which a particular group of consumers spend their money. It excludes the prices of capital

goods, raw materials and intermediate goods. It includes the prices of services as well as of imported goods.

The consumption basket depends on the level of income, rural-urban living, and type of profession the

family is engaged in, habits and customs and so on. It reflects the cost of living index condition for a

homogenous group based on retail price. It actually measures the increase in price that a consumer willultimately have to pay for.

CPI inflation rate = [(CPItCPIt-1)/CPIt-1]*100

CPIt = CPI of current year, CPIt-1 = CPI of pervious year

There are three measures of CPI. Set of goods and services for each CPI measure is different based on the

consumption pattern of the particular group:-

A) CPI for Industrial Workers (CPI-IW): The labour bureau of the Ministry of Labour compiles and

publishes data on CPI-IW. It is first prepared at the selected centres levels, and then aggregated to all Indialevel. The CPI-IW is currently available at 2001=100 base. For CPI-IW, a basket of 260 commodities is

tracked. It has got a broader coverage of set of goods and services, and that is why CPI-IW is extensively

used as cost of living index in organized sector.

B) CPI for Urban non-manual Employees (CPI-UNME): CPI-UNME is carried out by Central Statistical

Organization. It is first prepared at the selected centres levels, and then aggregated to all India levels.

Currently, this index is published with the base 1984-85=100. For CPI-UNME a basket of 180 commodities

is tracked.

C) CPI for Agricultural laborers (CPI-AL): The Labour bureau of the Ministry of Labour compiles and

publishes data on CPI-AL. It is first prepared at the state level and then aggregated to all India levels. CPI-

AL series is currently published for the base 1986-87=100. For CPI-AL a basket of 60 commodities is

tracked. The CPI-AL would give a greater weighted to food grain.

4. Producer Price Indexes (PPI)

These are indices that measure the average change over time in selling prices by producers of goods and

services. They measure price change from the point of view of the seller. Majority of OECD countries

measure inflation based on Producer Price Indiex (PPI) while only some others use WPI. Countries likeJapan, Greece, Norway and Turkey use WPI. Already WPI has been replaced in most of the countries by


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PPI due to the broader coverage provided by the PPI in terms of products and industries and the conceptual

concordance between PPI and system the national account. PPI is considered to be more relevant and

technically superior compared to one at wholesale level. However, in India we are still continuing with

WPI.

5. Cost-of-living indices (COLI):

This is different from CPI. This index aims to measure the effects of price changes on the cost of achieving

a constant standard of living (i.e. level of utility or welfare) as distinct from maintaining the purchasing

power to buy a fixed consumption basket of goods and services. Maintaining a constant standard of living

does not imply continuing to consume a fixed basket of goods and services. A COLI allows for the fact that

households who seek to maximize their welfare from a given expenditure can benefit by adjusting their

expenditure patterns to take account of changing relative prices by substituting goods that have become

relatively cheaper, for goods that have become relatively dearer. The use or preference for particular goods

may also change.


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Economic Effects of Inflation

The economic effects of inflation are all pervasive. It affects all those who depend on the market for their

livelihood. The effects of inflation may be favorable or unfavorable, depending on the rate of inflation.

When rate of inflation crosses safe limits it has adverse affect on the economy. It becomes inequalities. Poor

are rendered poorer.

1) Effect of inflation on distribution of income: The effect of inflation on income distribution

depends on how it affects the price received and price paid by different sections of the society, mainly the

consumers and the producers. Households receive their incomes in the form of factor prices- wages and

salaries, rent and royalties, profits, dividend, interest and income from self employment. Actual prices paid

represent the expenditures on consumer goods and production inputs. Inflation changes the income-

distribution-pattern only when it creates a divergence between total prices received and total prices paid by

different sections of the society. If inflation is predictable and consumers are able to adjust consumption

pattern and wage earners can move from low-wage jobs to high wage jobs, then the impact of inflation on

income distribution is considerably mitigated. But in general, product prices increase first and at a faster

rate, and input prices increase later and at a lower rate, because of a time lag between the rise in output

prices and input prices. Consequently, inflation causes redistribution of income in favor of the producers.

Firms get richer and laborers get poorer.

2) Effect of Inflation on distribution of Wealth: The effect of inflation on the distribution of

wealth depends on how inflation affects the net wealth, i.e. [net wealth = assets -liabilities] of the different

classes of wealth holders. Assets can be classified as:

A) Price Variable Assets: These assets are those whose prices change with change in the general pricelevel. The money value of these assets increases, during the period of inflation. These assets can be physical

assets including land, gold, automobiles, jewellery etc. and financial assets like stocks and shares.

B) Fixed Value Assets: These assets are those whose money value remains constant even if the general

price level changes. These assets include bonds, term deposits with banks and companies, loans and

advances, etc.

The effect of inflation on the net wealth depends on how inflation affects the money value of the price

variable assets. If price of all price-variable assets increase at the rate of inflation, then there will be no

change in asset portfolio and no change in wealth distribution.Inflation changes wealth distribution by changing the wealth accumulation ability of the different groups of

wealth holders. The ability to acquire wealth depends on the ability to save and ability to save depends on

the income. During the inflation, income of the high income groups increases at a higher rate than that of the

low income groups. Thus inflation changes wealth distribution in favor of the wealthy class of the society.

3) Effect of Inflation on different Sections of Society: Inflation has certain definite and

predictable effect on the income of certain sections of society, which are as follows:

A) Wage Earners: The labour market in the less developed countries, mostly in the country like India,

which facing a large scale open and disguised unemployment, are generally divided between organized andunorganized labour markets. The employment share of unorganized sector is much larger than that of the

organized sector. The wage rate in the unorganized labour market has not increased in proportion to the rate


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of inflation. So, the labour in this sector is a net loser during the period of inflation. The organized labour

uses its union power to get compensatory increase in their wages. The labour in this sector is adequately

compensated for the loss of purchasing power due to inflation. So the wage earners in this sector have

gained during the period of inflation.

B) Producers: Producers gain or loss due to inflation depends on the rates of increase in prices they receive

and the prices they pay. Product prices rise first and faster than the cost of production. These prices rise first

due to demand pull factors such as rise in money supply, rise in income, increase in investment, increase in

export etc. The input prices remaining the same, profit margin increases. This creates additional demand for

inputs pushing the input prices up, though at different rates and with different time lags. Other input prices

increase at a lower rate. So producers are the net gainers due to wage-lags during the period of inflation.

However, firms have to bear some additional cost during the period of inflation, especially when inflation

rate keeps increasing; firms are required to receive their prices, print new price lists and publicize their new

prices. The cost incurred for this purpose is called menu cost and in spite of these costs, the firms stand to

gain from inflation.

C) Fixed Income Class: The income of the fixed income class people remains constant during the period of

inflation but the prices of goods and services they consume increases. As a result, the purchasing power of

their income gets eroded in proportion to the rate of inflation and they become net losers during inflation.

D) Borrowers and Lenders: Under inflation borrowers gain and lenders lose because when borrower

repays to the lender under inflationary situation, then he will be returning less purchasing power to the

lender than what he borrowed earlier.

4) Effect of Inflation on Economic Growth: The rate of economic growth depends on the rate of

capital formation which depends on the rate of saving and investment. There is a positive relationship

between inflation and saving and investment and, therefore, inflation is conducive to economic growth.During the period of inflation, there is a time lag between the rise in output prices and rise in input prices,

which is called wage-lag. When the wage-lag persists over a long period of time, it increases the profit

margin. The increased profits provide both incentive for a larger investment and also the investible funds to

the firms. This results in an increase in production capacity and a higher level of output. Inflation tends to

redistribute incomes in favor of higher income groups. This kind of inflation increases total savings because

these upper income groups have a higher propensity to save. The increase in saving increases the supply of

investible funds and lowers the rate of interest. A lower rate of interest increases investment. With increase

in investment, production capacity of the economy increases. This causes an increase in the total output,

which means economic growth.

5) Effect of Inflation on Employment: Inflation has promotional effect on employment. Inflation

affects growth variables such as savings, investment and profits favorably and to increase in investment rate,

the rate of employment will also increase till the economy reaches the full employment level. A.W.Phillips,

a British economist found an inverse relationship between the rate of changes in the money wage rate and

the rate of unemployment. He presented this inverse relationship in the form of a curve, called Phillips

curve. According to this, the rise in money wage rate may be the cause or effect


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How to control Inflation?

MONETARY POLICY

Inflation is primarily a monetary phenomenon. Hence, the most logical solution to check inflation is to

check the flow of money supply by devising appropriate monetary policy and carefully implementing such

measures. To control inflation, it is necessary to control total expenditures because under conditions of fullemployment, increase in total expenditures will be reflected in a general rise in prices, that is, inflation.

Monetary policy is used to control inflation and is based on the assumption that a rise in prices is due to

excess of monetary demand for goods and services by the consumers/households e because easy bank credit

is available to them. Monetary policy, thus, pertains to banking and credit availability of loans to firms and

households, interest rates, public debt and its management, and the monetary standard. Monetary

management is aimed at the commercial banking systems, and through this action, its effects are primarily

felt in the economy as a whole. By directly affecting the volume of cash reserves of the banks, can regulate

the supply of money and credit in the economy, thereby influencing the structure of interest rates and the

availability of credit. Both these, factors affect the components of aggregate demand and the flow ofexpenditure in the economy. The central banks monetary management methods, the devices for decreasing

or increasing the supply of money and credit for monetary stability is called monetary policy. Central banks

generally use the three quantitative measures to control the volume of credit in an economy, namely:

1. Raising bank rates

2. Open market operations and

3. Variable reserve ratio

However, there are various limitations on the effective working of the quantitative measures of credit

control adapted by the central banks and, to that extent, monetary measures to control inflationary

weakened. In fact, in controlling inflation moderate monetary measures, by themselves, are relatively

ineffective. On the other hand, drastic monetary measures are not good for the economic system because

they may easily send the economy into a decline. In a developing economy there is always an increasing

need for credit. Growth requires credit expansion but to check inflation, there is need to contract credit. In

such an encounter, the best course is to resort to credit control, restricting the flow of credit into the

unproductive, inflation-infected sectors and speculative activities, and diversifying the flow of credit

towards the most desirable needs of productive and growth-inducing sector. It should be noted that the

impression that the rate of spending can be controlled rigorously by the contraction of credit or money

supply is wrong in the context of modern economic societies. In modern community, tangible, wealth istypically represented by claims in the form of securities, bonds, etc., or near moneys, as they are called.

Such near moneys are highly liquid assets, and they are very close to being money. They increase the

general liquidity of the economy. In these circumstances, it is not so simple to control the rate of spending or

total outlays merely by controlling the quantity of money. Thus, there is no immediate and direct

relationship between money supply and the price level, as is normally conceived by the traditional quantity

theories. When there is inflation in an economy, monetary restraints can, in conjunction with other

measures, play a useful role in controlling inflation.


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FISCAL MEASURES

Fiscal policy is another type of budgetary policy in relation to taxation, public borrowing, and public

expenditure. To curve the effects of inflation and changes in the total expenditure, fiscal measures would

have to be implemented which involves an increase in taxation and decrease in government spending.

During inflationary periods the government is supposed to counteract an increase in private spending. It can

be cleared noted that during a period of full employment inflation, the aggregate demand in relation to thelimited supply of goods and services is reduced to the extent that government expenditures are

shortened. Along with public expenditure, governments must simultaneously increase taxes that would

effectively reduce private expenditure, in an effect to minimize inflationary pressures. It is known that when

more taxes are imposed, the size of the disposable income diminishes, also the magnitude of the inflationary

gap in regards to the availability of the supply of goods and services. In some instances, and tax policy

has been directed towards restricting demand without restricting level of production. For example, excise

duties or sales tax on various commodities may take away the buying power from the consumer goods

market without discouraging the level of production. However, some economists point out that this is not a

correct way of combating inflation because it may lead to a regressive status within the economy. As a

result, this may lead to a further rise in prices of goods and services, and inflation can spread from one sector

of the economy to another and from one type of goods and services to another. Therefore, a reduction in

public expenditure, and an increase in taxes produces a cash surplus in the budget. Keynes, however,

suggested a programme of compulsory savings, such as deferred pay as an anti-inflationary measure.

Deferred pay indicates that the consumer defers a part of his or her wages by buying savings bonds (which,

of course, is a sort of public borrowing), which are redeemable after a particular period of time, this is

sometimes called forced savings. Additionally, private savings have a strong disinflationary effect on the

economy and an increase in these is an important measure for controlling inflation. Government policy

should therefore, include devices for increasing savings. A strong savings drive reduces the spendable

income of the consumers, without any harmful effects of any kind that are associated with higher taxation.Furthermore, the effects of a large deficit budget, which is mainly responsible for inflation, can be partially

offset by covering the deficit through public borrowings. It should be noted that it is

only government borrowing from non-bank lenders that has a disinflationary effect. In addition, public debt

may be managed in such a way that the supply of money in the country may be controlled. The government

should avoid paying back any of its past loans during inflationary periods, in order to prevent an increase in

the circulation of money. Anti-inflationary debt management also includes cancellation of public debt held

by the central bank out of a budgetary surplus. Fiscal policy by itself may not be very effective in combating

inflation; therefore a combination of fiscal and monetary tools can work together in achieving the desired

outcome.

DIRECT MEASURES OF CONTROL

Direct controls refer to the regulatory measures undertaken toconvert an open inflation into a repressed one.

Such regulatory measures involve the use of direct control on prices and rationing of scarce goods. The

function of price controls a fix a legal ceiling, beyond which prices of particular goods may not increase.

When ceiling prices are fixed and enforced, it means prices are not allowed to raise further and so, inflation

issuppressed.Under price control; producers cannot raise the price beyond a specified level, even though

there may be a pressure of excessive demand forcing it up. For example, during wartimes, price control wasused to suppress inflation. In times of the severe scarcity of certain goods, particularly, food grains,


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government may have to enforce rationing, along with price control. The main function of rationing is to

divert consumption from those commodities whose supply needs to be restricted for some special reasons;

such as, to make the commodity more available to a larger number of households. Therefore, rationing

becomes essential when necessities, such asfood grains, are relatively scarce. Rationing has the effect of

limiting the variety of quantity of goods available for the

good cause of price stability and distributive impartiality. However, according to Keynes, rationing

involves a great deal of waste, both of resources and of employment.

Another control measure that was suggested is the control of wages as it often becomes necessary in order to

stop a wage-price spiral. During galloping inflation, it may be necessary to apply awage-

profit freeze. Ceiling s on wages and profits keep down disposable income and, therefore the total effective

demand for goods and services. On the other hand, restrictions on imports may also help to increase

supplies of essential commodity and ease the inflationary pressure. However, this is possible only to a

limited extent, depending upon the balance of payments situation. Similarly, exports may also be reduced in

an effort to increase the availability of the domestic supply of essential commodities so that inflation is

eased. But a country with a deficit balance of payments cannot dare to cut exports and increase imports,

because the remedy will be worse than the disease itself. In overpopulated countries like India, it is also

essential to check the growth of the population through an effective family

planning programme, because this will help in reducing the increasing pressure on the general demand for

goods and services. Again, the supp

report on effects of inflation in india

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