1905 30-Apr-2018, Mon
What is inflation?
Inflation is a sustained rate at which the general level of prices of goods or services are increasing, and at the same time the rate of purchasing power of currencies are decreasing. Inflation is measured as an annual change in percentage.
Prices of things rise over time under conditions of inflation and as it does, every currency you own buys smaller percentage of service/good. Therefore, when prices rise and currencies fall, you have inflation. The purchasing power is the expression of the value of currencies. Purchasing power, is the amount of tangible/real goods/services the money can buy at a moment in time. When there’s inflation, there’s decline in the purchasing power of money.
According to Crowther, “Inflation is State in which the Value of Money is Falling and the Prices are rising.”
In Economics, the word ‘inflation’ refers to General rise in Prices Measured against a Standard Level of Purchasing Power.
In 2014 1 Kg of Rice = Rs 40
In 2016 1 Kg of Rice = Rs 60
The above increase in price of rice. The purchasing power of money has decline as the same amount of good is available at higher price. Hence, the above price rise of rice over a period of time is called as inflation that is affecting the purchasing power of the people .This in turn reduces the value of money as for each commodity we have to spend more than the previous one.
What causes inflation?
There’s no single theory behind the cause of inflation that economists/academics agree upon. However, there are a few commonly held hypotheses:
1. Demand-pull inflation
This theory can be summarized as “too much money chasing too few goods”. It is a mismatch between demand and supply , if demand is growing faster than supply, prices will increase. This usually occurs in growing economies as more people gain purchasing power while the supply is not able to catch up to growing demand.When the government of a country print money in excess, prices increase to keep up with the increase in currency, leading to inflation.
2. Cost-push inflation
According to cost-push inflation, inflation is caused when production costs of companies rise. When production costs (taxes, wages, imports, etc.) increase, companies increase the prices of their goods/services to maintain their profit margins.
3. Monetary inflation
According to this theory, inflation is caused by the excessive supply of money in economies. Prices of commodities are determined by their demand & supply. When the supply is excess, the prices of commodities go down. If the commodity is money, excess supply of money reduces its value and the result is that the prices of everything else priced in currencies (dollars, rupees, etc.) must go up.
What are the different types of inflation?
A. Creeping inflation:
Creeping is a mild inflation, which occurs when there is price rise of 3% or less a year. According to the Federal Reserve, when there’s a rise of 2% or less in prices, it benefits the economic growth. The creeping inflation makes consumers expect that the prices will keep increasing, which in turn boosts demand for goods and services, as consumers now want to buy a lot to beat the future prices. And this, is how creeping inflation drives economic expansion. This is also the reason for Federal Reserve to set 2% as its target inflation rate.
B. Walking inflation:
Walking is a stronger inflation, somewhere with price rise between 3% to 10% a year. Walking inflation is harmful to the economy, as it accelerates economic growth (too fast). As a result consumers start purchasing goods/services more than their requirement to avoid higher future prices. This further increases the demand so much that it’s challenging for suppliers to keep up with the demands. This results in common services/goods being priced out of reach of most people.
C. Galloping inflation:
When inflation rises to 10% of more, there’s a havoc wrecked on the economy. The currencies lose value so drastically that incomes of employees and business can’t keep up with prices and costs. This leads to instability in the Economy and loss in credibility of the government leaders. This is the type of inflation that must be prevented at all costs.
Increase in inflation beyond the inflation range of 2 or 3%, could lead to hyperinflation, a condition where inflation quickly rises out of control. Hyperinflation occurs when prices skyrocket more than 50% a month. Hyperinflation is a rare phenomenon. Some examples of hyperinflation are Germany in 1920s, Zimbabwe in 2000s and America during its civil war.
Stagflation is when the growth in economy becomes stagnant, but there’s still price inflation. This seemingly contradictory phenomena is rare like hyperinflation, but can create havoc in economy by combining high unemployment rate, severe inflation and poor economic growth. Stagflation is a huge challenge to Central banks, due to increase in risks associated with monetary policy responses and fiscal. Central banks usually increase interest rates to combat high inflation, but doing so during stagflation could increase unemployment further. Therefore, central banks need to keep a limit on their ability to decrease rates during stagflation. Possibly the most difficult inflation to manage.
F. Core inflation:
This type of inflation measures the rising prices of all commodities except energy and food, due to the fact that gas prices increase every summer.
G. Wage inflation:
Wage inflation occurs when wages of workers rise faster than the cost of living. Wage inflation occurs when there are labor unions demanding higher wages, when workers control their pay or when there’s a shortage of workers.
H. Asset inflation:
Asset inflation refers to increase in prices of one asset class (gold, oil, housing, etc.). Asset inflation is often overlooked by inflation watchers when the overall inflation is low.
I. Suppressed Inflation:
Existing inflation disguised by government Price controls or other interference in the economy such as subsidies. Such suppression, nevertheless, can only be temporary because no governmental measure can completely contain accelerating inflation in the long run. It is Also Called Repressed Inflation.
Effect of Inflation –
a) They add inefficiencies in the market, and make it difficult for companies to budget or plan long-term.
b) Uncertainty about the future purchasing power of money discourages investment and saving.
c) There can also be negative impacts to trade from an increased instability in currency exchange prices caused by unpredictable inflation.
d) Higher income tax rates.
e) Inflation rate in the economy is higher than rates in other countries; this will increase imports and reduce exports, leading to a deficit in the balance of trade.
Measurement of Inflation
Inflation is measured by calculating the percentage rate of change of a price index, which is called the inflation rate.
Inflation is often measured either in terms of Wholesale Price Index or in terms of Consumer Price Index.
Wholesale Price Index(WPI) :
The Wholesale Price Index is an indicator designed to measure the changes in the price levels of commodities that flow into the wholesale trade intermediaries. The index is a vital guide in economic analysis and Policy formulation. It is a basis for price adjustments in business contracts and projects. It is also intended to serve as an additional source of information for comparisons on the international front.
Consumer Price Index (CPI):
Consumer price index is specific to particular group in the population. It shows the cost of living of the group. It is based on the changes in the retail prices of goods or services. Based on their incomes, consumer spends money on these particular set of goods and services. There are different consumer price indices. Each index tracks the changes in the retail prices for different set of consumers.
Consequences of Inflation –
Adverse effect on production
Adverse effect on distribution of income
Obstacle to development
Changes in relative prices
Adverse effect on the B.O.P (Balance of Payment)
Measures of Inflation –
Demonetization of Currency
Issue of New Currency
Reduction in Unnecessary Expenditure
Increase in Taxes
Increase in Savings
To Increase Production
Rational Wage Policy
Inflation a threat to Indian economy -
a) Inflation has become a household name for millions of Indians who are finding it extremely difficult to make both ends meet. Prices are growing faster than the household income almost for all products and services including real estate, food, transportation, luxuries.
b) The global economic crisis saw many economies stumble but India rebounded faster and was surging ahead with a growth rate of 9%. But the inflationary pressure is forcing the government to adopt measures which are taking the steam out of the Indian growth story
c) For the last two years India is witnessing double digit food inflation which had reached a high of around 18% in December 2010 with prices of onions, garlic and tomatoes skyrocketing. Lentils, milk and meat have witnessed a steady rise in prices which is putting pressure on the home budget of millions of Indians.
d) Millions of poor people in India are struggling to arrange a two-square meal for their family members. We are running the risk of having an entire generation of malnourished children who are otherwise considered the future of India.
e) The tightening of the economy may control inflation in the long run but it is also slowing our economy and as predicted by the IMF India’s growth will be only around 6-7% instead of 9%.
Current status of inflation in India –
- Currently inflation rate is around 9.44% in India, much above the acceptable rate of 5%.
- The food price index is at 8.31% causing much discomfort to the policymakers. which under the current scenario seems impossible.
How to Control Inflation –
Monetary Measures –
- Credit Control
- Issue of new currency
Fiscal Measures –
- Reduction in Unnecessary Expenditure
- Increase in taxes
- Increase in savings
- Surplus Budgets
- Public Debts
- To increase in production
- Rational wage policy
- Price control