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Inflation

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Inflation: Concepts and Meaning


Inflation: meaning
Inflation refers to a state in the economy where too much money chases too little goods and services. In such state there is general increase in the price level of goods and services over a period of time which results into fall of value of money.

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1. Creeping Inflation: It is the mildest form of inflation where prices rise by not more than 3% per annum. 2. Walking Inflation: In the case of walking inflation the prices rise by more than 3% but less than 10% per annum. 3. Running Inflation: An economy is said to be encountering the Running Inflation, when the rate of inflation is 10% to 20% per annum (double digit inflation rate). 4. Galloping Inflation: If the prices rise by more than 20% but less than 1000% per annum, galloping inflation occurs. It is also referred to as jumping inflation. India has been witnessing galloping inflation since the second five year plan period. 5. Hyperinflation: Hyperinflation refers to a situation when prices rise above 1000% per annum (quadruple or four digit inflation rate). In case of hyperinflation there is such rapid rise in the price level and fall in value of money that people start losing faith in the paper currency of the government. During a worst case scenario of hyperinflation paper money becomes worthless. Two worst examples of hyperinflation recorded in world history are of those experienced by Hungary in year 1946 and Zimbabwe during 2004-2009. 6. Stagflation: It is a situation where inflation coexists with stagnation i.e. recession and unemployment. Classical economics referred this situation as paradoxical. 7. Recession: It is defined as the situation in the economy which is marred by a negative growth rate of GDP for two or more successive quarters. 8. Core Inflation: It refers to inflation which does not include the impact of such factors which are beyond the control of the government. For example international oil prices etc. 9. Depression: It an extreme form of recession where there is contraction in business cycles, fall in demand and investments, rise in unemployment levels, which results to business pessimism and total collapse of economy. In technical terms an economy is encountering depression if either of the following two conditions holds good: A decline in real GDP exceeding 10%. A recession lasting 2 or more years i.e. negative growth rate of GDP for eight or more successive quarters.

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Causes of Inflation
Inflation may be caused by either an increase in the money supply (demand pull) or a decrease in the quantity of goods (cost push) being supplied.
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Inflation

Demand pull factors:


1. Increase in population of the country 2. Rise in money supply due to deficit financing or printing of excessive currency 3. Rises in wage and salaries in the country 4. Increase in black money or parallel economy 5. Rise in expenditure of the government especially under the non-plan expenditure head.

Cost push factor:


1. Shortfall of production in the agriculture mainly because of erratic rainfall during monsoon 2. Rise in international fuel prices 3. Rise in income, wages and salaries 4. Speculation, black marketing and hoarding etc. 5. Increase in the import bill due to price hike in the international market especially for inputs like machinery and raw materials. At any given point of time inflation is the result of a mix of these two factors.

Consequences of Inflation
On development:
Inflation severely affects the condition of marginalized and economically weaker section of the society. It hampers the food security by making the food commodities unaffordable. It also reduces the spending on access to basic healthcare and education when the bulk of the earnings of the poor household goes in the food bill. Inflation escalates the cost of various developmental and infrastructure projects, thus retarding their pace and feasibility.

On income inequality:
Inflation can result into the malpractices like speculation, black marketing and hoarding. It can also lead to increase in black money. All these factors augment the income inequalities and corruption in the society.

On exports and Balance of payments:


Inflation makes exports less competitive due to higher pricing. As a result the exports might get reduce at the same time imports may rise. This could distort the trade pattern and severely affect the Balance of payment and foreign exchange reserves of the country.
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Mechanism to curb Inflation


The mechanism to curb inflation can be divided into three broad categories i.e. monetary policy, fiscal policy and administrative measures:

Monetary Policy
Through monetary policy the supply of money is regulated is the market. Inflation refers to a state in the economy where too much money chases too little goods and services, thus the aim of monetary policy to curb inflation is to reduce the money supply from the market. By adjusting Bank Rate, Cash Reserve Ratio (CRR), Statutory Liquidity Ratio (SLR), Repo rate, Reverse repo rate etc the central bank can reduce the money supply from the market.

Flip side of monetary controls


The reduced money supply or the dear money policy makes the credit and loans dearer. This could hamper the growth of economy, where the dear money policy acts as a disincentive for investment.

Fiscal Policy
The aim of fiscal policy while curbing the inflation is to reduce the government expenditure. The aim is to especially reduce the spending under the non plan expenditure. On the other hand the reduction in indirect taxes like VAT, sale tax etc could also help in curbing the cost push inflation.

Flip side of fiscal controls


In the country like India where bulk of population cannot afford the goods and services at market rate, the reduction in government expenditure that too under non plan expenditure (which includes subsides and transfer payments) would severely affect the agenda of socio-economic transformation and inclusive growth. Furthermore, the reduction in indirect taxes could result in reduction in income of the state.

Administrative measures
The following can be the administrative mechanisms to curb the inflation in the country: 1. Curbing the malpractices like black marketing and hoarding. 2. Strengthening the Public Distribution System (PDS) in the country 3. Timely liberalizing the import of such essential commodities like sugar, edible oils etc where there had been shortfall. 4. Temporary ban on the export of such essential commodities which have been facing shortfall in the domestic markets. For e.g. in 2008-09, government of India banned the export of non-Basmati rice.

Measurement of Inflation in India


The Indian government has taken Wholesale Price Index (WPI) as an indicator of the rate of inflation in the economy.
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India is perhaps the only major country that uses WPI to measure inflation. In most of the countries the consumer indices are used to calculate inflation.

Wholesale Price Index (WPI)


WPI is based on the price prevailing in the wholesale markets or the price at which bulk transactions are made. In India, a total of 676 commodities data on price level is tracked through WPI which is an indicator of movement in prices of commodities in all trade and transactions. The base year for the porpose of calculation is 2004-05. It is also the price index which is available on a monthly basis. The Ministry of Commerce and Industry has recently made a decision to discontinue the weekly Wholesale Price Index (WPI) of primary articles and fuel and power components. The primary articles and fuel and power components are traditionally some of the most volatile components of price index components. The Cabinet Committee on Economic Affair believes that these data add little analytical value to the existing monthly WPI data but possibly misrepresent changes in Indias inflation scenario.

Issues with WPI


WPI accounts for wholesale prices, however they are different from the retail prices or the prices at which the end consumer buys the goods. Thus WPI at times might not reflect the real picture. WPI doesnt take the price of services into consideration WPI is too general and cannot be used for specific purposes for different sectors. Some commodities may have higher weights during a particular season and may not be consumed during other. For example, woollen textiles are part of the consumption basket only for four months in a city like Chandigarh. So a constant revision of weights is required in this regard, which WPI does not take into consideration. Consumer Price Index (CPI) is much more representative index for common man as in this index; nearly 57% weight-age is given to the food and primary articles

Need for Producer Price Index (PPI)


Producer Price Index (PPI) would capture the price levels at the producer level itself. Many countries across the world have switched over to Producer Price Index. The major effect of PPI could be that it can help to take corrective measures before the inflation effects the end consumer. Go to Previous Page

Comments
# Tejaswi
2012-05-17 23:16

0 Reply | Reply w ith quote | Quote

WPI is on monthly basis...

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# Tejaswi
2012-05-17 23:20

Inflation
-1 Reply | Reply w ith quote | Quote

..and it's 676 commodities

2012-10-01 22:10 -1 Negative grow th rate during recession w ould mean fall in grow th rate or fall in grow th(GDP) ? Reply | Reply w ith quote | Quote

# Jagadeesh

2012-10-30 13:19

-1 Reply | Reply w ith quote | Quote

Why is India still using WPI?

2013-05-02 10:25

Dear team, WPI significantly reduces the numerical value of inflation as services are not accounted for and moving to PPI w ould further low er the numerical value of inflation. This w ould give some breathing space to the government in its fiscal policy approach. But how w ould the consumer w ho are most effected by inflation as significant amount from their savings goes into buying essential commodities be relieved from inflation ? NOTE :- PPI w ould address constraints at producer level only and it w ould still not take into account the services and challenges at consumer levels. Reply | Reply w ith quote | Quote

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