1. WHAT IS INFLATION ?

WRITE IN DETAIL ABOUT THE

TYPES OF INFLATION?

Inflation and unemployment are the two most talked-about words in the
contemporary society.

These two are the big problems that plague all the economies.

Almost everyone is sure that he knows what inflation exactly is, but it remains a
source of great deal of confusion because it is difficult to define it unam-
biguously.

1. Meaning of Inflation:
Inflation is often defined in terms of its supposed causes. Inflation exists when
money supply exceeds available goods and services. Or inflation is attributed to
budget deficit financing. A deficit budget may be financed by the additional
money creation. But the situation of monetary expansion or budget deficit may
not cause price level to rise. Hence the difficulty of defining ‘inflation’

It is to be pointed out here that inflation is a state of disequilibrium when there

occurs a sustained rise in price level. It is inflation if the prices of most goods
go up. Such rate of increases in prices may be both slow and rapid. However, it
is difficult to detect whether there is an upward trend in prices and whether this
trend is sustained. That is why inflation is difficult to define in an unambiguous
sense.

Let’s measure inflation rate. Suppose, in December 2007, the consumer price
index was 193.6 and, in December 2008, it was 223.8. Thus, the inflation rate
during the last one year was

223.8- 193.6/ 193.6 x 100 = 15.6

As inflation is a state of rising prices, deflation may be defined as a state of

falling prices but not fall in prices. Deflation is, thus, the opposite of inflation,
i.e., a rise in the value of money or purchasing power of money. Disinflation is
a slowing down of the rate of inflation.

2. Types of Inflation:
As the nature of inflation is not uniform in an economy for all the time, it is
wise to distinguish between different types of inflation. Such analysis is useful

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to study the distributional and other effects of inflation as well as to recommend
anti-inflationary policies. Inflation may be caused by a variety of factors. Its
intensity or pace may be different at different times. It may also be classified in
accordance with the reactions of the government toward inflation.

Thus, one may observe different types of inflation in the contemporary

society:
1. Demand-pull inflation

This occurs when AD increases at a faster rate than AS. Demand pull inflation
will typically occur when the economy is growing faster than the long run trend
rate of growth. If demand exceeds supply, firms will respond by pushing up
prices. This represents a situation where the basic factor at work is the increase
in aggregate demand for output either from the government or the entrepreneurs
or the households. The result is that the pressure of demand is such that it
cannot be met by the currently available supply of output.

If, for example, in a situation of full employment, the government expenditure

or private investment goes up, this is bound to generate inflationary pressures in
the economy. Keynes explained that inflation arises when there occurs an
inflationary gap in the economy which comes to exist when aggregate demand
exceeds aggregate supply at full employment level of output. Basically,
inflation is caused by a situation whereby the pressure of aggregate demand for
goods and services exceeds the available supply of output (both being counted
at the prices ruling at the beginning of a period). In such a situation, the rise in
price level is the natural consequence.

Now, this imbalance between aggregate demand and supply may be the result of
more than one force at work. As we know aggregate demand is the sum of
consumers’ spending on consumer goods and services, government spending on
consumer goods and services and net investment being contemplated by the
entrepreneurs?

Simple diagram showing demand pull inflation

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 If aggregate demand (AD) rises faster than productive capacity (LRAS), then
firms will respond by putting up prices, creating inflation.

 Inflation – a sustained increase in the price level.

 Demand-pull inflation – inflation caused by AD increasing faster than AS.

Demand-pull inflation means:

 Excess demand and ‘too much money chasing too few goods.’
 The economy is at full employment/full capacity.
 The economy will be growing at a rate faster than the long-run trend rate.
 A falling unemployment rate.

How demand-pull inflation occurs

If aggregate demand is rising at 4%, but productive capacity is only rising at
2.5%; firms will see demand outstripping supply. Therefore, they respond by
increasing prices.
Also, as firms produce more, they employ more workers, creating a rise in
employment and fall in unemployment. This increased demand for workers puts
upward pressure on wages, leading to wage-push inflation. Higher wages
increase disposable income of workers leading to a rise in consumer spending.
Economic growth and long-run trend rate
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 The long trend rate of economic is the sustainable rate of economic growth; it is
the rate of economic without any demand-pull inflation. If economic growth
exceeds this long-run trend rate, then it will cause inflationary pressures.
In a boom, growth is above the long-run trend rate, and it is in this situation
where we will get demand-pull inflation.
Causes of demand-pull inflation

 Lower interest rates. A cut in interest rates causes a rise in consumer spending
and higher investment. This boost to demand causes a rise in AD and
inflationary pressures.
 The rise in house prices. Rising house prices create a positive wealth effect and
boost consumer spending. This leads to a rise in economic growth.
 Rising real wages. For example, unions bargaining for higher wage rates.
 Devaluation. Devaluation in the exchange rate increases domestic demand
(exports cheaper, imports more expensive). Devaluation will also cause cost-
push inflation (imports more expensive)

Demand pull inflation and Phillips Curve

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 Demand pull inflation can also be shown on a
Phillips Curve. A rise in demand causes a fall in unemployment (from 6% to
3%) but an increase in inflation from inflation of 2% to 5%.

2. Cost-push inflation:
Inflation in an economy may arise from the overall increase in the cost of
production. This type of inflation is known as cost-push inflation (henceforth
CPI). Cost of production may rise due to an increase in the prices of raw
materials, wages, etc. Often trade unions are blamed for wage rise since wage
rate is not completely market-determinded. Higher wage means high cost of
production. Prices of commodities are thereby increased.

A wage-price spiral comes into operation. But, at the same time, firms are to be
blamed also for the price rise since they simply raise prices to expand their
profit margins. Thus, we have two important variants of CPI wage-push in-
flation and profit-push inflation.

Anyway, CPI stems from the leftward shift of the aggregate supply curve:

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Four Causes of Cost-Push Inflation

Cost-push inflation occurs under five special circumstances.

In all of these circumstances, demand is inelastic.

1. Monopoly

Companies that achieve a monopoly over an industry create cost-push inflation.

A monopoly reduces supply to meet its profit goal.

A good example is OPEC, the Organization of Petroleum Exporting Countries.

It sought monopoly power over oil prices. Before OPEC, its members competed
with each other on price. They didn't receive a reasonable value for a non-
renewable natural resource. OPEC members now produce 42 percent of oil each
year. They control 80 percent of the world's proven oil reserves. OPEC
members created cost-push inflation during the 1970s oil embargo.
When OPEC restricted oil in 1973, it quadrupled prices. In 2014, shale oil
producers challenged OPEC's monopoly power. Prices dropped as a result. For
more, see U.S. Shale Oil Boom and Bust.

2. Wage inflation

Wage inflation occurs when workers have enough leverage to force through
wage increases. Companies then pass higher costs through to consumers. The
U.S. auto industry experienced it when labor unions were able to push for
higher wages. Thanks to China and the decline of union power in the United
States, it hasn't been a driver of inflation for many years.

3. Natural Disasters.

Natural disasters cause inflation by disrupting supply. A good example is right

after Japan's earthquake in 2011. It disrupted the supply of auto parts. It also
occurred after Hurricane Katrina. When the storm destroyed oil refineries, gas
prices soared.

The depletion of natural resources is type of natural disaster. It works the same
way, by limiting supply and causing inflation. For example, fish prices are
rising due to overfishing. Recent U.S. laws try to prevent it by limiting the catch
for fishermen.

4. Government Regulation and Taxation

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A fourth driver is government regulation and taxation. These rules can reduce
supplies of many other products. Taxes on cigarettes and alcohol were meant to
lower demand for these unhealthy products. That may have happened, but more
important it raised the price, creating inflation.

Government subsidies of ethanol production led to soaring food prices in 2008.

Agribusinesses grew corn for energy production, taking it out of the food
supply. Food prices were so high that there were food riots around the world
that year.

3.IMPORTED INFLATION
If the quantity of imports increases, this should reduce domestic demand-pull
inflation
(AD = C+I+G+X-M). Therefore if consumers spend more on imports it
will, ceteris paribus, reduce domestic demand. Therefore, we get lower growth
of AD and lower inflation.
Suppose there is an increase in the marginal propensity to import. Rather than
20% of consumer spending going on imports, this rises to 30% – then this
implies less spending on domestic goods.

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 If higher imports cause lower domestic demand, we will see lower inflation.
Imports and an economic boom
However, often a rise in imports occurs because there is a rise in general
spending. For example, in the UK in the late 1980s, there was rapid growth in
real incomes – this caused both domestic demand-pull inflation and also a rise
in imports. (causing trade deficit)

In this case, the rise in spending on imports occurred alongside an increase in

the inflation rate.
Imports and exchange rate
The other effect is that a rise in imports will, ceteris paribus, cause a
depreciation in the exchange rate. This is because to buy imports, we have to
supply more pounds to be able to buy foreign imports. This rise in the supply of
sterling causes a depreciation in the pound.
A depreciation in the exchange rate tends to increase inflationary pressure
because:

 Imports become more expensive

 Exports and AD increase causing demand-pull inflation

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 With more competitive exports, firms have less incentive to cut costs

It is one of those issues where it is impossible to say with certainty exactly what
will happen. It depends on which effect is bigger – the reduction in AD or
depreciation in the exchange rate. Overall, I would imagine the impact on
inflation of higher imports to be negligible.
It’s a bit like saying how do higher interest rates effect current account deficit?

 Higher interest rates increase exchange rate worsening current account

 But, on the other hand, higher interest rates reduce consumer spending, reduce
imports and improve the current account.

How inflation may affect import spending

Suppose the UK saw a rise in inflation and this caused UK inflation rate to be
higher than its main competitors. In this case, UK goods would become less
competitive – leading to lower demand for domestically produced goods.
Instead, consumers would look to buy more imports because they will be more
competitive.

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 2. What are the problems arised due to inflation?
Causes of inflation
Inflation means there is a sustained increase in the price level. The main causes
of inflation are either excess aggregate demand (economic growth too fast) or
cost push factors (supply-side factors).

Summary of Main causes of inflation

1. Demand-pull inflation – aggregate demand growing faster than aggregate

supply (growth too rapid)
2. Cost-push inflation – higher oil prices feeding through into higher costs
3. Devaluation – increasing cost of imported goods, also boost to domestic
demand
4. Rising wages – higher wages increase firms costs and increase consumers’
disposable income to spend more.

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5. Expectations of inflation – causes workers to demand wage increases and firms
to push up prices.
6. Cost-push inflation can be caused by many factors

1. Rising wages
If trades unions can present a united front then they can bargain for higher
wages. Rising wages are a key cause of cost push inflation because wages
are the most significant cost for many firms. (higher wages may also
contribute to rising demand)
2. Import prices
One-third of all goods are imported in the UK. If there is a
devaluation, then import prices will become more expensive leading to an
increase in inflation. A devaluation / depreciation means the Pound is worth
less. Therefore we have to pay more to buy the same imported goods.

In 2011/12, the UK experienced a rise in cost-push inflation, partly due to

the depreciation of the Pound against the Euro. (also due to higher taxes)
3. Raw material prices

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 The best example is the price of oil. If the oil price increase by 20% then this
will have a significant impact on most goods in the economy and this will
lead to cost-push inflation. E.g., in 1974 there was a spike in the price of oil
causing a period of high inflation around the world.

Source: World Bank. In 2008, we had a smaller spike in oil prices

causing a rise in inflation – just before the great recession of 2008/09

4. Profit push inflation

When firms push up prices to get higher rates of inflation. This is more
likely to occur during strong economic growth.
5. Declining productivity
If firms become less productive and allow costs to rise, this invariably
leads to higher prices.
6. Higher taxes
If the government put up taxes, such as VAT and Excise duty, this will lead
to higher prices, and therefore CPI will increase. However, these tax rises are

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likely to be one-off increases. There is even a measure of inflation (CPI-CT)
which ignores the effect of temporary tax rises/decreases.

CPI-CT is less volatile because it ignores the effect of taxes. In 2010, some
of the UK CPI inflation was due to rising taxes.

else could cause inflation

7. 1. Rising house prices
Rising house prices do not directly cause inflation, but they can cause a
positive wealth effect and encourage consumer-led economic growth. This
can indirectly cause demand-pull inflation.
2. Printing more money
If the Central Bank prints more money, you would expect to see a rise in
inflation. This is because the money supply plays an important role in
determining prices. If there is more money chasing the same amount of
goods, then prices will rise. Hyperinflation is usually caused by an extreme
increase in the money supply.
However, in exceptional circumstances – such as liquidity trap/recession, it
is possible to increase the money supply without causing inflation. This is
because, in recession, an increase in the money supply may just be saved,
e.g. banks don’t increase lending but just keep more bank reserves.
Inflation expectations
Once inflation sets in it is difficult to reduce inflation. For example, higher
prices will cause workers to demand higher wages causing a wage-price
spiral. Therefore, expectations of inflation are important. If people expect
high inflation, it tends to be self-serving.

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 The attitude of the monetary authorities is important; for example, if there
was an increase in AD and the monetary authorities accommodated this
by increasing the money supply then there would be a rise in the price
level.
The advantages of inflation
1. Deflation (a fall in prices – negative inflation) is very harmful. When
prices are falling, people are reluctant to spend money because they feel goods
will be cheaper in the future; therefore they keep delaying purchases. Also,
deflation increases the real value of debt and reduces the disposable income of
individuals who are struggling to pay off their debt. When people take on a debt
like a mortgage, they generally expect an inflation rate of 2% to help erode the
value of debt over time. If this inflation rate of 2% fails to materialise, their debt
burden will be greater than expected. Periods of deflation caused serious
problems for the UK in 1920s, Japan in 1990s and 2000s and Eurozone in
2010s.
2. Moderate inflation enables adjustment of wages. It is argued a moderate
rate of inflation makes it easier to adjust relative wages. For example, it may be
difficult to cut nominal wages (workers resent and resist a nominal wage cut).
But, if average wages are rising due to moderate inflation, it is easier to increase
the wages of productive workers; unproductive workers can have their wages
frozen – which is effectively a real wage cut. If we had zero inflation, we could
end up with more real wage unemployment, with firms unable to cut wages to
attract workers.
3. Inflation enables adjustment of relative prices. Similar to the last point,
moderate inflation makes it easier to adjust relative prices. This is particularly
important for a single currency like the Eurozone. Southern European countries
like Italy, Spain and Greece became uncompetitive, leading to large current
account deficit. Because Spain and Greece cannot devalue in the Single
Currency, they have to cut relative prices to regain competitiveness. With very
low inflation in Europe, this means they have to cut prices and cut wages which
cause lower growth (due to the effects of deflation). If the Eurozone had
moderate inflation, it would be easier for southern Europe to adjust and regain
competitive without resorting to deflation.
4. Inflation can boost growth. At times of very low inflation, the economy
may be stuck in a recession. Arguably targeting a higher rate of inflation can
enable a boost in economic growth. This view is controversial. Not all
economists would support targeting a higher inflation rate. However, some
would target higher inflation, if the economy was stuck in a prolonged
recession. See: Optimal inflation rate

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 For example, the Eurozone has had a very low inflation rate in 2013-14, and this
has corresponded to very weak economic growth and very high unemployment.
If the ECB had been willing to target higher inflation, then we could have seen a
rise in Eurozone GDP.
Disadvantages of inflation
Inflation is usually considered to be a problem when the inflation rate rises
above 2%. The higher the inflation, the more serious the problem is. In extreme
circumstances, hyper inflation can wipe away people’s savings and cause great
instability, e.g. Germany 1920s, Hungary 1940s, Zimbabwe 2000s. However, in
a modern economy, this kind of hyper inflation is rare. Usually, inflation is
accompanied with higher interest rates, so savers do not see their savings wiped
away. However, inflation can still cause problems.

 Inflationary growth tends to be unsustainable leading to a damaging period

of boom and bust economic cycles. For example, the UK saw high inflation in
the late 1980s, but this economic boom was unsustainable and when the
government tried to reduce inflation, it led to the recession of 1990-92.
 Inflation tends to discourage investment and long term economic growth. This
is because of the uncertainty and confusion that is more likely to occur during
periods of high inflation. Low inflation is said to encourage greater stability and
encourage firms to take risks and invest.
 Inflation can make an economy uncompetitive. For example, a relatively higher
rate of inflation in Italy can make Italian exports uncompetitive, leading to
lower AD, a current account deficit and lower economic growth. This is
particularly important for countries in the Euro-zone because they can’t devalue
to restore competitiveness.
 Reduce the value of savings. Inflation leads to a fall in the value of money. This
makes savers worse off – if inflation is higher than interest rates. High inflation
can lead to a redistribution of income in society. Often it is pensioners who lose
out most from inflation. This is particularly a problem if inflation is high and
interest rates low.
 Menu costs – the cost of changing prices lists becomes more frequent during
high inflation. Not so significant with modern technology.
 Fall in real wages. In some circumstances, high inflation can lead to a fall in
real wages. If inflation is higher than nominal wages, then real incomes fall.
This was a problem in the great recession of 2008-16, with prices rising faster
than income

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 3. WRITE AND EXPLAIN DIFFERENT WAY TO CURB
INFLATION?

There are many methods used to control inflation, some work well,
while some may have having damaging consequences such as a recession. For
example, controlling inflation through wage and price controls can cause a
recession and hurt the people whose jobs are lost because of it.

One popular method of controlling inflation is through

a contractionary monetary policy. The goal of a contractionary policy is to
reduce the money supply within an economy by decreasing bond prices and
increasing interest rates. This helps reduce spending because when there is less
money to go around, those who have money want to keep it and save it, instead
of spending it. It also means that there is less available credit, which can
also reduces spending. Reducing spending is important during inflation, because
it helps halt economic growth and, in turn, the rate of inflation. One popular
method of controlling inflation is through a contractionary monetary policy. The
goal of a contractionary policy is to reduce the money supply within an
economy by decreasing bond prices and increasing interest rates. This helps
reduce spending because when there is less money to go around, those who
have money want to keep it and save it, instead of spending it. It also means that
there is less available credit, which can also reduces spending. Reducing
spending is important during inflation, because it helps halt economic growth
and, in turn, the rate of inflation.

There are three main ways to carry out a contractionary policy. The first is to
increase interest rates through the Federal Reserve. The Federal Reserve rate is
the rate at which banks borrow money from the government, but, in order to
make money, they must lend it at higher rates. So, when the Federal Reserve
increases its interest rate, banks have no choice but to increase their rates as
well. When banks increase their rates, less people want to borrow money
because it costs more to do so while that money accrues at a higher interest. So,
spending drops, prices drop and inflation slows. money accrues at a higher
interest. So, spending

drops, prices drop and inflation slows.The second method is to increase reserve
requirements on the amount of money banks are legally required to keep on
hand to cover withdrawals. The more money banks are required to hold back,
the less they have to lend to consumers. If they have less to lend, consumers
will borrow less, which will decrease spending.

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The third method is to directly or indirectly reduce the money supply by
enacting policies that encourage reduction of the money supply. Two examples
of this include calling in debts that are owed to the government and increasing
the interest paid on bonds so that more investors will buy them. The latter
policy raises the exchange rate of the currency due to higher demand and, in
turn, increases imports and decreases exports. Both of these policies will reduce
the amount of money in circulation because the money will be going from
banks, companies and investors pockets and into the government’s pocket
where they can control what happens to it

Some of the important measures to control inflation are as follows: 1. Monetary

Measures 2. Fiscal Measures 3. Other Measures.

Inflation is caused by the failure of aggregate supply to equal the increase in

aggregate demand. Inflation can, therefore, be controlled by increasing the
supplies of goods and services and reducing money incomes in order to control
aggregate demand.

The various methods are usually grouped under three heads: monetary
measures, fiscal measures and other measures.

1. Monetary Measures:
Monetary measures aim at reducing money incomes.

(a) Credit Control:

One of the important monetary measures is monetary policy. The central bank
of the country adopts a number of methods to control the quantity and quality of
credit. For this purpose, it raises the bank rates, sells securities in the open
market, raises the reserve ratio, and adopts a number of selective credit control
measures, such as raising margin requirements and regulating consumer credit.
Monetary policy may not be effective in controlling inflation, if inflation is due
to cost-push factors. Monetary policy can only be helpful in controlling inflation
due to demand-pull factors.

(b) Demonetisation of Currency:

However, one of the monetary measures is to demonetise currency of higher
denominations. Such a measures is usually adopted when there is abundance of
black money in the country.

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(c) Issue of New Currency:
The most extreme monetary measure is the issue of new currency in place of the
old currency. Under this system, one new note is exchanged for a number of
notes of the old currency. The value of bank deposits is also fixed accordingly.
Such a measure is adopted when there is an excessive issue of notes and there is
hyperinflation in the country. It is a very effective measure. But is inequitable
for its hurts the small depositors the most.

2. Fiscal Measures:
Monetary policy alone is incapable of controlling inflation. It should, therefore,
be supplemented by fiscal measures. Fiscal measures are highly effective for
controlling government expenditure, personal consumption expenditure, and
private and public investment.

The principal fiscal measures are the following:

(a) Reduction in Unnecessary Expenditure:

The government should reduce unnecessary expenditure on non-development

activities in order to curb inflation. This will also put a check on private
expenditure which is dependent upon government demand for goods and
services. But it is not easy to cut government expenditure. Though this measure
is always welcome but it becomes difficult to distinguish between essential and
non-essential expenditure. Therefore, this measure should be supplemented by
taxation.

(b) Increase in Taxes:

To cut personal consumption expenditure, the rates of personal, corporate and
commodity taxes should be raised and even new taxes should be levied, but the
rates of taxes should not be so high as to discourage saving, investment and
production. Rather, the tax system should provide larger incentives to those who
save, invest and produce more.

Further, to bring more revenue into the tax-net, the government should penalise
the tax evaders by imposing heavy fines. Such measures are bound to be

18
effective in controlling inflation. To increase the supply of goods within the
country, the government should reduce import duties and increase export duties.

(c) Increase in Savings:

Another measure is to increase savings on the part of the people. This will tend
to reduce disposable income with the people, and hence personal consumption
expenditure. But due to the rising cost of living, people are not in a position to
save much voluntarily

Keynes, therefore, advocated compulsory savings or what he called ‘deferred

payment’ where the saver gets his money back after some years. For this
purpose, the government should float public loans carrying high rates of
interest, start saving schemes with prize money, or lottery for long periods, etc.
It should also introduce compulsory provident fund, provident fund-cum-
pension schemes, etc. All such measures increase savings and are likely to be
effective in controlling inflation.

d) Surplus Budgets:
An important measure is to adopt anti-inflationary budgetary policy. For this
purpose, the government should give up deficit financing and instead have
surplus budgets. It means collecting more in revenues and spending less.

(e) Public Debt:

At the same time, it should stop repayment of public debt and postpone it to
some future date till inflationary pressures are controlled within the economy.
Instead, the government should borrow more to reduce money supply with the
public.

Like monetary measures, fiscal measures alone cannot help in controlling

inflation. They should be supplemented by monetary, non-monetary and non-
fiscal measures.

3. Other Measures:
The other types of measures are those which aim at increasing aggregate supply
and reducing aggregate demand directly.

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(a) To Increase Production:
The following measures should be adopted to increase production:
(i) One of the foremost measures to control inflation is to increase the
production of essential consumer goods like food, clothing, kerosene oil, sugar,
vegetable oils, etc.

(ii) If there is need, raw materials for such products may be imported on
preferential basis to increase the production of essential commodities,

(iii) Efforts should also be made to increase productivity. For this purpose,
industrial peace should be maintained through agreements with trade unions,
binding them not to resort to strikes for some time,

(iv) The policy of rationalisation of industries should be adopted as a long-term

measure. Rationalisation increases productivity and production of industries
through the use of brain, brawn and bullion,

(v) All possible help in the form of latest technology, raw materials, financial
help, subsidies, etc. should be provided to different consumer goods sectors to
increase production.

(b) Rational Wage Policy:

Another important measure is to adopt a rational wage and income policy.
Under hyperinflation, there is a wage-price spiral. To control this, the
government should freeze wages, incomes, profits, dividends, bonus, etc.

But such a drastic measure can only be adopted for a short period as it is likely
to antagonise both workers and industrialists. Therefore, the best course is to
link increase in wages to increase in productivity. This will have a dual effect. It
will control wages and at the same time increase productivity, and hence raise
production of goods in the economy.

(c) Price Control:

Price control and rationing is another measure of direct control to check
inflation. Price control means fixing an upper limit for the prices of essential
consumer goods. They are the maximum prices fixed by law and anybody
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charging more than these prices is punished by law. But it is difficult to
administer price control.

(d) Rationing:
Rationing aims at distributing consumption of scarce goods so as to make them
available to a large number of consumers. It is applied to essential consumer
goods such as wheat, rice, sugar, kerosene oil, etc. It is meant to stabilise the
prices of necessaries and assure distributive justice. But it is very inconvenient
for consumers because it leads to queues, artificial shortages, corruption and
black marketing. Keynes did not favour rationing for it “involves a great deal of
waste, both of resources and of employment.”

Conclusion:
From the various monetary, fiscal and other measures discussed above, it
becomes clear that to control inflation, the government should adopt all
measures simultaneously. Inflation is like a hydra- headed monster which
should be fought by using all the weapons at the command of the government.

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4.EXPLAIN THE FOLLOWING TERM?

CRR

SLR

GDP

REPORATE

The article is authored by Square Capital research team. Square Capital is

India's first unbiased loan advisor for best deals on all types of loans and is
known for its unmatched advisory services. It is the mortgage arm of Square
Capital - India's largest real estate transactions company.
Across the globe it is the government in-power which issues the currency notes
and that currency is known as the "Legal Tender" i.e. accepted by all in that
country. In India it is the role of the Central bank of the country i.e Reserve
Bank of India that prints currency notes and it bears the Governor's signature on
it.
The primary functions of RBI is:
1.To control the supply of money in the economy i.e how much money is
available for the industry or the economy and
2. The cost of credit.' meaning, and what is the price that the economy has to
pay to borrow that money.
These two things (Supply of money and cost of credit) are closely monitored
and controlled by RBI. The inflation and growth in the economy are primarily
impacted by these two factors.
The various methods employed by the RBI to control credit creation power of
the commercial banks can be classified into two groups, viz., quantitative
controls and qualitative controls.
Quantitative controls are designed to regulate the volume of credit created by
the banking system Qualitative measures or selective methods are designed to
regulate the flow of credit in specific uses.
To control inflation and the growth, RBI uses certain tools like CASH
RESERVE RATIO, STATUTORY LIQUIDITY RATIO, REPO RATE, and
REVERSE REPO RATE

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The current CRR is 4%. If RBI cuts CRR in its next monetary policy review
then it will mean banks will be left with more money to lend or to invest. So,
more money can be released into the economy which may spur economic
growth.

Cash reserve Ratio is the amount of funds that the banks have to keep with
the RBI. If the central bank decides to increase the CRR, the available amount
with the banks comes down. The RBI uses the CRR to drain out excessive
money from the system. Commercial banks are required to maintain with the
RBI an average cash balance, the amount of which shall not be less than 3%
of the total of the Net Demand and Time Liabilities (NDTL), on a fortnightly
basis and the RBI is empowered to increase the rate of CRR to such higher
rate not exceeding 20% of the NDTL.

What is Statutory Liquidity Ratio (SLR)?

Besides CRR, Banks have to invest certain percentage of their deposits in
specified financial securities like Central Government or State Government
securities. This percentage is known as SLR.
This money is predominantly invested in government approved securities
(bonds), Gold, which mean the banks can earn some amount as 'interest' on
these investments as against CRR where they do not earn anything.
Example - An Individual deposits say Rs 1000 in bank. Then Bank receives Rs
1000 and has to keep some percentage of it with RBI as SLR. If the prevailing
SLR is 20% then they will have to invest Rs 200 in Government Securities

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So to meet both CRR and SLR requirements, bank have to earmark Rs 260 (Rs
60 + Rs 200).

Higher reserve requirements such as SLR make banks relatively safe (as a
certain portion of their deposits are always redeemable) but at the same time
restrict their capacity to lend. To that extent, lowering of reserve requirement
increases the resources available with a bank to lend and helps control inflation
and propels growth.
What is Repo Rate?
When we need money, we take loans from banks. And banks charge certain
interest rate on these loans. This is called as cost of credit (the rate at which we
borrow the money).
Similarly, when banks need money they approach RBI. The rate at which banks
borrow money from the RBI by selling their surplus government securities to
RBI is known as "Repo Rate." Repo rate is short form of Repurchase Rate.
Generally, these loans are for short durations up to 2 weeks.

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It simply means Repo Rate is the rate at which RBI lends money to commercial
banks against the pledge of government securities whenever the banks are in
need of funds to meet their day-to-day obligations.
Banks enter into an agreement with the RBI to repurchase the same pledged
government securities at a future date at a pre-determined price. RBI manages
this repo rate which is the cost of credit for the bank.
Example - If repo rate is 5% , and bank takes loan of Rs 1000 from RBI , they
will pay interest of Rs 50 to RBI.
So, higher the repo rate higher the cost of short-term money and vice versa.
Higher repo rate may slowdown the growth of the economy.
If the repo rate is low then banks can charge lower interest rates on the loans
taken by us.
So whenever the repo rate is cut, can we expect both the deposit rates and
lending rates of banks to come down to some extent?
This may or may not happen every time. The lending rate of banks goes down
to the existing bank borrowers only when the banks reduce their base rates
(Base Rate is the minimum rate below which Banks are not permitted to lend)
as all lending rates of banks are linked to the base rate of every bank. In the
absence of a cut in the base rate, the repo rate cut does not get automatically
transmitted to the individual bank customers. This is the reason why you might
have observed that your loan EMIsremain same even after RBI lowers the repo
rates.
Banks check various other factors (like credit to deposit ratios etc.,) before
reducing the Base rates.
What is Reverse Repo Rate?
Reverse repo rate is the rate of interest offered by RBI, when banks deposit their
surplus funds with the RBI for short periods. When banks have surplus funds
but have no lending (or) investment options, they deposit such funds with RBI.
Banks earn interest on such funds.
Current CRR, SLR, Repo and Reverse Repo Rates:
The current rates are (as of last week of December 2015) - CRR is 4 % , SLR
is 21.50%, Repo Rate is 8% and Reverse Repo Rate is 7%.
RBI website has repository of all CRR, SLR & Base Rates
Impact of Repo Rate /CRR/SLR rate cut :

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 (A term called as "Basis Points" is often used in monetary policy reviews. What
is Basis Point? …. 1% is equivalent to 100 basis points.e.g. If Repo Rate is
7.75% and RBI increases it by 25 basis point, then new rate will be 8% as 25
basis point will be equal to 0.25%)
Here are some points on 'how the RBI's rate cuts impact homeloans-
 The RBI's rate cuts does not necessarily mean that the borrowers benefit
immediately. The landing bank has to reduce its Base Lending rate for EMI to
decrease.
 These rate cuts will not have any impact on fixed rate home loans or fixed rate
consumer loans. The rate of interest is fixed with respect to fixed loans.
 The existing bank customers (who have taken loans) can see either their Loan
tenures or EMIs coming down. By default the banks reduce the loan tenure
instead of loan EMI. That means your monthly EMI installment amount remains
the same. The rate cut will make a substantial difference if the remaining loan
term/tenure is very long.

GDP
Gross domestic product is the best way to measure a country's economy.
GDP is the total value of everything produced by all the people and
companies in the country. It doesn't matter if they are citizens or foreign-
owned companies. If they are located within the country's boundaries, the
government counts their production as GDP. Types

There are many different ways to measure a country's GDP. It's important to
know all the different types and how they are used.

Nominal GDP: This is the raw measurement that includes price increases.
The Bureau of Economic Analysis measures nominal GDP quarterly. It revises
the quarterly estimate each month as it receives updated data. In 2016, the
nominal U.S. GDP was $18.625 trillion.

Real GDP: To compare economic output from one year to another, you must
account for the effects of inflation. To do this, the BEA calculates real GDP. It
does this by using a price deflator. It tells you how much prices have changed
since a base year. The BEA multiplies the deflator by the nominal GDP. The
BEA makes the following three important distinctions.

1. Income from U.S. companies and people from outside the country are not
included. That removes the impact of exchange rates and trade policies.
2. The effects of inflation are taken out.

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 3. Only the final product is counted. For example, a U.S. footwear
manufacturer uses laces and other materials made in the United States.
Only the value of the shoe gets counted. The shoelace does not.

Real GDP is lower than nominal. In 2016, it was $16.716 trillion. The BEA
provides it using 2009 as the base year in the Interactive Tables, Table 1.1.6.
Real Gross Domestic Product Chained Dollars.

Growth Rate: The GDP growth rate is the percent increase in GDP from
quarter to quarter. It tells you exactly how fast a country's economy is growing.
Most countries use real GDP to remove the effect of inflation.

The BEA calculates the U.S. growth rate. It provides current GDP
statistics monthly. For the forecast, see U.S. GDP Growth. Compare it to
the business cycle phases in U.S. GDP by Year Since 1929.

GDP per Capita: This is the best way to compare gross domestic
product between countries. That's because some countries have enormous
economic outputs because they have so many people. To get a more accurate
picture, it's helpful to use GDP per capita. This divides gross domestic
product by the number of residents. It’s a good measure of the
country's standard of living. The 2016 U.S. GDP per capita was $57,300.

The best way to compare gross domestic product by year and between countries
is with real GDP per capita. This takes out the effects of inflation, exchange
rates and differences in population.

What It Tells You About the Economy

The different measures of GDP are great tools for comparing the economies of
other countries or how an economy changes over time. When economists talk
about the “size” of an economy, they are referring to GDP. In 2007, the United
States lost its position as the world's largest economy.

The growth rate measures whether the economy is growing more quickly or
more slowly than the quarter before. If it produces less than the quarter before,
it contracts and the growth rate is negative. This signals a recession. If it stays
negative long enough, the recession turns into a depression. As bad as a
recession is, you also don't want the growth rate to be too high. Then you'll get
inflation. The ideal growth rate is between 2 percent to 3 percent.

How It Affects You

The GDP impacts personal finance, investments and job growth.

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Investors look at the growth rate to decide if they should adjust their asset
allocation. They also compare country growth rates to decide where the best
opportunities are. Most investors like to purchase shares of companies that are
in rapidly growing countries.

The Federal Reserve uses the growth rate to decide whether to

implement expansionary monetary policy to ward off recession
or contractionary monetary policy to prevent inflation. For more, see The
Federal Funds Rate and How It Works.

Let's say the growth rate is speeding up. The Fed raises interest rates to stem
inflation. In this case, you would want to lock in a fixed-rate mortgage. You
know that an adjustable-rate mortgage will start charging higher rates next year.

If growth slows down or is negative then you should dust off your resume. Slow
economic growth usually leads to layoffs and unemployment. Thatcan take
several months. That's because it takes time for executives to compile the layoff
list and exit packages.

You could use the GDP report from the BEA to look at which sectors of the
economy are growing and which are declining. You can apply for jobs
in growing sectors. Even during the 2008 financial crisis, health care industries
continued to add jobs. This report also helps you determine whether you should
invest in, say, a tech-specific mutual fund versus a fund that focuses on
agribusiness.

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