Macro EconomicsAssignment

Inflation

Submitted to: Dr. Venkatraja B

Submitted by: Group 4, Section CGeorge Joy (14056)Gopal G (14057)Gouri Patil (14058)Isha Gupta (14065)Kailash Bisht (141066)Kamal Kishore Vyas (14067)

Shri Dharmasthala Manjunatheswara Institute for

Management Development,

Mysore, India

Contents

Business Cycle.............................................................................................................................................1

Stages of a Business Cycle.......................................................................................................................1

Factors That Shape Business Cycles.........................................................................................................1

What Is Inflation?....................................................................................................................................3

What Are The Types Of Inflation?............................................................................................................4

What Are The Causes Of Inflation?..........................................................................................................6

Causes for Demand Pull Inflation.............................................................................................................6

Causes of Cost Pull Inflation:-..................................................................................................................7

What Are the Impacts of Inflation?.........................................................................................................8

Recent Trends of Inflation in India...............................................................................................................9

Chart – current CPI inflation India (yearly basis) – last 12 months........................................................11

Current Inflation in India (CPI) – Last 12 Months (2014)........................................................................12

Reserve Bank.........................................................................................................................................14

Government Role..................................................................................................................................16

How Inflation affects various sectors.........................................................................................................17

Agriculture Sector..................................................................................................................................17

Automobile Industry..............................................................................................................................18

Conclusion.............................................................................................................................................19

Business CycleThe business cycle is the periodic but irregular up-and-down movement in economic activity, measured by fluctuations in real gross domestic product (GDP) and other macroeconomic variables. A business cycle is typically characterized by four phases – recession, recovery, growth, and decline – that repeat themselves over time. Economists note, however, that complete business cycles vary in length. The duration of business cycles can be anywhere from about two to twelve years, with most cycles averaging six years in length. Some business analysts use the business cycle model and terminology to study and explain fluctuations in business inventory and other individual elements of corporate operations. But the term "business cycle" is still primarily associated with larger (industry-wide, regional, national, or even international) business trends.

Stages of a Business Cycle

Recession:

A recession (also sometimes referred to as a trough) – Is a period of reduced economic activity in which levels of buying, selling, production, and employment typically diminish. This is the most unwelcome stage of the business cycle for business owners and consumers alike. Particularly severe recession is known as a depression.

Recovery:

Also known as an upturn, the recovery stage of the business cycle is the point at which the economy "troughs" out and starts working its way up to better financial footing.

Growth:

Economic growth is in essence a period of sustained expansion. Hallmarks of this part of the business cycle include increased consumer confidence, which translates into higher levels of business activity. Because the economy tends to operate at or near full capacity during periods of prosperity, growth periods are generally accompanied by inflationary pressures.

Decline:

Also referred to as a contraction or downturn, a decline basically marks the end of the period of growth in the business cycle. Declines are characterized by decreased levels of consumer purchases (especially of durable goods) and, subsequently, reduced production by businesses.

Factors That Shape Business Cycles

Economists, corporate executives, and business owners cite several factors as particularly important in shaping the complexion of business environments. The factors are:

Volatility of Investment Spending:

Variations in investment spending is one of the important factors in business cycles. Investment spending is considered the most volatile component of the aggregate or total demand (it varies much more from year to year than the largest component of the aggregate demand, the consumption spending)

There are several reasons for the volatility that can often be seen in investment spending. In general, if an increase in sales is expanding, investment spending rises, and if an increase in sales has peaked and is beginning to slow, investment spending falls. Thus, the pace of investment spending is influenced by changes in the rate of sales.

Momentum:

Many economists cite a certain "follow-the-leader" mentality in consumer spending. In situations where consumer confidence is high and people adopt more free-spending habits, other customers are deemed to be more likely to increase their spending as well. Conversely, downturns in spending tend to be imitated as well.

Technological Innovations:

Technological innovations can have an acute impact on business cycles. Indeed, technological breakthroughs in communication, transportation, manufacturing, and other operational areas can have a ripple effect throughout an industry or an economy. Technological innovations may relate to production and use of a new product or production of an existing product using a new process.

Variations in Inventories:

Variations in inventories – expansion and contraction in the level of inventories of goods kept by businesses – also contribute to business cycles. Inventories are the stocks of goods firms keep on hand to meet demand for their products. Increase in inventory levels as companies begin to produce more than is sold, leading to an economic expansion. This expansion continues as long as the rate of increase in sales holds up and producers continue to increase inventories at the preceding rate. However, as the rate of increase in sales slows, firms begin to cut back on their inventory accumulation. The subsequent reduction in inventory investment dampens the economic expansion, and eventually causes an economic downturn.

The business cycles generated by fluctuations in inventories are called minor or short business cycles. These periods, which usually last about two to four years, are sometimes also called inventory cycles.

Fluctuations in Government Spending:

Government spending increased by an enormous amount during World War II, leading to an economic expansion that continued for several years after the war. However, government spending not only contributes to economic expansions, but economic contractions as well.

Politically Generated Business Cycles:

Many economists have hypothesized that business cycles are the result of the politically motivated use of macroeconomic policies (monetary and fiscal policies) that are designed to serve the interest of politicians running for re-election. The theory of political business cycles is predicated on the belief that elected officials (the president, members of Congress, governors, etc.) have a tendency to engineer expansionary macroeconomic policies in order to aid their re-election efforts.

Monetary Policies:

Use of fiscal policy – Increased government spending and/or tax cuts – Is the most common way of boosting aggregate demand, causing an economic expansion. The Central Bank, in the case of the United States, the Federal Reserve Bank, has two legislated goals – price stability and full employment. Its role in monetary policy is a key to managing business cycles and has an important impact on consumer and investor confidence as well.

Fluctuations in Exports and Imports:

The difference between exports and imports is the net foreign demand for goods and services, also called net exports. Because net exports are a component of the aggregate demand in the economy, variations in exports and imports can lead to business fluctuations as well. There are many reasons for variations in exports and imports over time. Growth in the gross domestic product of an economy is the most important determinant of its demand for imported goods – as people's incomes grow, their appetite for additional goods and services, including goods produced abroad, increases. The opposite holds when foreign economies are growing – growth in incomes in foreign countries also leads to an increased demand for imported goods by the residents of these countries. This, in turn, causes U.S. exports to grow. Currency exchange rates can also have a dramatic impact on international trade – and hence, domestic business cycles – as well.

What Is Inflation?

Inflation is defined as a sustained increase in the general level of prices for goods and services. It is measured as an annual percentage increase. As inflation rises, every dollar you own buys a smaller percentage of a good or service.

There are several variations on inflation:

1. Deflation, it is when the general level of prices is falling. This is the opposite of inflation. 2. Hyperinflation, it is unusually rapid inflation. In extreme cases, this can lead to the

breakdown of a nation's monetary system. One of the most notable examples of hyperinflation occurred in Germany in 1923, when prices rose 2,500% in one month!

3. Stagflation, it is the combination of high unemployment and economic stagnation with inflation. This happened in industrialized countries during the 1970s, when a bad economy was combined with OPEC raising oil prices.

What Are The Types Of Inflation?

There are two types of inflation, they are:

Demand-Pull Inflation:

A term used in Keynesian economics to describe the scenario that occurs when price levels rise because of an imbalance in the aggregate supply and demand. If the economy is at or close to full employment then an increase in AD leads to an increase in the price level. As firms reach full capacity, they respond by putting up prices, leading to inflation. Also, near full employment, workers can get higher wages which increases their spending power.

This theory can be summarized as "too much money chasing too few goods". In other words, if demand is growing faster than supply, prices will increase. This usually occurs in growing economies.

Example of demand pull inflation in the UK

In the 1980s, the UK experienced rapid economic growth. The government cut interest rates and also cut taxes. House prices rose by up to 30% fuelling a positive wealth effect and a rise in consumer confidence. This increased confidence led to higher spending, lower saving and an increase in borrowing. However, the rate of economic growth reached 5% a year – well above the UK’s long run trend rate of 2.5 %. The result was a rise in inflation as firms could not meet demand. It also led to a current account deficit.

Cost-Push Inflation:

A phenomenon in which the general price levels rise (inflation) due to increases in the cost of wages and raw materials. When companies' costs go up, they need to increase prices to maintain their profit margins. Increased costs can include things such as wages, taxes, or increased costs of imports. If there is an increase in the costs of firms, then firms will pass this on to consumers.

What Are The Causes Of Inflation?

There are several causes on inflation. Some of them are:-

Causes for Demand Pull Inflation

Growth Of Black Money - Black money is unaccounted money. Its money about which government have not record. Illegal acts such as black-marketing, corruption, land grabbing, Betting etc. are main source of such type of Money. Black money affects inflation in following ways:-

1. With Black money, people have financial Flexibility and they become financially strong. Black Money is surplus money over their actual and legit income and is considered as illegal money. When people have surplus money, they buy different commodities easily as they have surplus money. This raises demand of goods and hence leads to Inflation.

2. Sometimes people use illegal money to buy commodities on large scale and stores these commodities with themselves. This is called hoarding. This creates artificial scarcity in the market as if the supply of the commodity is very less Here, Again demand become greater than supply. Hence Prices of products rises, giving rise to Inflation. Shopkeepers and Businessmen adopt this Practice to earn higher profit margins as due to this Gap in Demand and Supply created by them, They Charge Higher Prices for the commodity. Higher prices = Greater Profits

Increasing Population - Increasing Population means Increase in number of people. High birth rate, Immigration, lower death rate etc. are the main causes of Increasing population. Needs of people will increase with increase in population. There will be a rise in number of consumers in the market. People will demand more goods. Since by rising population, demand of goods rises, it leads to demand Pull Inflation.

Increase In Savings Of Consumer - When common man, Has more saving then he will spend more by demanding goods. Since, he/she can use their savings to improve their

standard of living, they will demand goods on a regular basis. This Increases the Demand Of goods in the market. Hence Leads to Increase In prices.

Expectation Of Inflation - This is one of the most important Cause of Inflation. When people predict that inflation can come in future, so they start buying Goods before prices Increase. This leads To Increase in demand in the market. By this, their prediction about Inflation gives birth to Demand Pull Inflation.

Perception About Big Brands - Perception of people about Big brands matter a lot. Since, Big Brands have Huge Funds, They have access to Advance resources by which they advertise their products to make a good perception about their product in the minds of people. This creates high demand for their products. For example. Demand of Apple products is very high in the market as compared to any other brand. This is because, people think that Apple products are better than any other brand. Due to high demand, Apple Products have high prices. This sometimes leads to Demand -Pull Inflation as the company may not be able to supply as many products as demanded by the people.

Causes of Cost Pull Inflation:-

Cost push inflation can be caused by many factors

1. Rising wagesIf trades unions can present a common 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 pricesOne 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.

3. Raw Material PricesThe 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 early 2008, there was a spike in the price of oil to over $150 causing a temporary rise in inflation.

4. Profit Push InflationWhen firms push up prices to get higher rates of inflation. This is more likely to occur during strong economic growth.

5. Declining productivityIf firms become less productive and allow costs to rise, this invariably leads to higher prices.

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

What else could cause inflation?Rising house pricesRising 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

Printing more moneyIf 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.

What Are the Impacts of Inflation?

The term "inflation" refers to rising prices of essentials such as wheat, milk, meat, clothing, medical services, coffee, electricity, etc. or, alternatively, the decline in value of money so that it takes more dollars to buy the same goods and services.

1. The major effect of inflation is that a nation's nominal currency loses value. That is, it takes more Dollars, or Pounds Sterling, or Euros, or Yen, or Swiss Francs, to buy the same quantity of goods.

2. There are two other effects of inflation. The effect of inflation on savers and investors is that they lose purchasing power.

Whether you've buried your money in a coffee can in the back yard or it is sitting in the safest bank in the world, it is becoming less valuable with the passage of time.

The effect of inflation on debtors is positive because debtors can pay their debts with money that is less valuable. If you owed $100,000 at 5% interest, but inflation suddenly spiked to 20% per year, you are effectively watching 15% of your debt get paid off each year, totally free to you. At some point, you'd be able to get a minimum wage job at McDonald's for $100 per hour and just obliterate your debt.

3. The net effect of inflation is that it serves to transfer money from savers and investors to debtors. It punishes those who postpone their enjoyment and invested in building roads, schools, factories, and businesses and gives their reward to those who are in

debt. It is a severe moral injustice, mostly caused by governments printing money to cover expenses that cannot be paid out of the general treasury revenue.

4. Another major effect of inflation is the damage it can do to the pocketbooks of average workers. Wages and salaries can lag cost of living increases, making families struggle to keep up as the price of everything from cornflakes to tuition increases faster than the take-home pay they receive from employers.

Recent Trends of Inflation in India Inflation Rate in India is reported by the Ministry of Statistics and Program Implementation (MOSPI), India. In January 2007, there was a dramatic increase in inflation to 6 percent, much higher than the Reserve Bank of India’s(RBI) stated band of 5 to 5.5 percent. Inflation increased alarmingly to touch 6.6 percent in March 2007. Thereafter, it declined to reach 3.6 per cent in December 2007.However, March 2008 saw inflation cross 6.5 percent. The acceleration continues with inflation hitting 8.24 per cent in the week ending on May 24, 2008.

In 2008 the global financial crisis struck following which inflation rose sharply both in advanced countries and EDEs as commodity and oil prices rebounded. Thereafter, inflation rate moderated both in advanced economies and EDEs. In India to the inflation rate rose from 4.7 per cent in 2007-08 to 8.1 per cent in 2008-09 and fell to 3.8 per cent in 2009- 10. However, the inflation rate backed up and stayed near double digits during 2010-11 and 2011-12 before showing some moderation in 2012-13.The high inflation during 2010 and 2011 was a combination of both adverse global and domestic factors as well as supply and demand factors

Inflation Rate in India averaged 8.98 percent from 2012 until 2014, reaching an all-time high of 11.16 percent in November of 2013 and a record low of 4.38 percent in November of 2014. The inflation rate in India was recorded at 5 percent in December of 2014.

Inflation rate in 2012-2013

Inflation rate of 2013-2014

Inflation rate in 2012-2014

MONTHLY TREND OF THE YEAR 2014

Chart – current CPI inflation India (yearly basis) – last 12 months

Current Inflation in India (CPI) – Last 12 Months (2014)

INFLATION (MONTHLY BASIS) INFLATION (YEARLY BASIS)

November 2014 - October 2014 0.00 % November 2014 - November 2013 4.12 %

October 2014 - September 2014 0.00 % October 2014 - October 2013 4.98 %

September 2014 - august 2014 0.00 % September 2014 - September 2013 6.30 %

August 2014 - July 2014 0.40 % August 2014 - August 2013 6.75 %

July 2014 - June 2014 2.44 % July 2014 - July 2013 7.23 %

June 2014 - May 2014 0.82 % June 2014 - June 2013 6.49 %

May 2014 - April 2014 0.83 % May 2014 - May 2013 7.02 %

April 2014 - march 2014 1.26 % April 2014 - April 2013 7.08 %

March 2014 - February 2014 0.42 % March 2014 - March 2013 6.70 %

February 2014 - January 2014 0.42 % February 2014 - February 2013 6.73 %

January 2014 - December 2013 -0.84 % January 2014 - January 2013 7.24 %

December 2013 - November 2013 -1.65 % December 2013 - December 2012 9.13 %

Inflation rate in the year 2014.

INDIA CONSUMER INFLATION CLIMBS TO 5% IN 2014:

Indian CPI inflation increased for the first time in five months to 5 percent in December of 2014 from a record-low of 4.38 percent the previous month and driven by higher food prices.

Cost of food and beverages rose 5 percent, accelerating from a 3.5 percent increase in November, provisional estimates showed. The food alone index rose 4.78 percent (3.14 percent in November). Cost of vegetables went up 0.58 percent and fruit prices increased 14.84 percent (13.74 percent in November). In contrast, price decreases were reported for oils and fats (-1.24 percent) and sugar (-0.84 percent).

Cost of fuel and light rose 3.41 percent in December, slightly up from 3.27 percent in November and cost of clothing and footwear slowed to 6.51 percent from 6.97 percent in the previous month. The corresponding provisional inflation rates for rural and urban areas for December of 2014 are 4.71 percent and 5.32 percent.

Present scenario in the Globe, how is it affecting India?

Within the last decade or so, three fundamental changes have occurred in the very fabric of the world economy:

The primary-products economy has come "uncoupled" from the industrial economy. In the industrial economy itself, production has come "uncoupled" from employment. Capital movements rather than trade (in both goods and services) have become the

driving force of the world economy. The two have not quite come uncoupled, but the link has become loose, and worse, unpredictable.

These changes are permanent rather than cyclical. We may never understand what caused them—the causes of economic change are rarely simple. It may be a long time before economic theorists accept that there have been fundamental changes, and longer still before they adapt their theories to account for them. Above all, they will surely be most reluctant to accept that it is the world economy in control, rather than the macroeconomics of the nation-state on which most economic theory still exclusively focuses. Yet this is the clear lesson of the success stories of the last 20 years—of Japan and South Korea; of West Germany (actually a more impressive though far less flamboyant example than Japan); and of the one great success within the United States, the turnaround and rapid rise of an industrial New England, which only 20 years ago was widely considered that it lacked vitality.

First, let’s consider the primary-products economy. The collapse of non-oil commodity prices began in 1977 and has continued, interrupted only once (right after the 1979 petroleum panic), by a speculative burst that lasted less than six months; it was followed by the fastest drop in commodity prices ever registered. By early 1986 raw material prices were at their lowest levels

in recorded history in relation to the prices of manufactured goods and services—in general as low as at the depths of the Great Depression, and in some cases (e.g., lead and copper) lower than their 1932 levels.

Contrary to all these expectations, global agricultural output actually rose almost one-third between 1972 and 1985 to reach an all-time high. It rose the fastest in less-developed countries. Similarly, production of practically all forest products, metals and minerals has gone up between 20 and 35 percent in the last ten years—again with the greatest increases in less-developed countries. There is not the slightest reason to believe that the growth rates will slacken, despite the collapse of commodity prices. Indeed, as far as farm products are concerned, the biggest increase—at an almost exponential rate of growth—may still be ahead.

Position of India Economy

The stock of foreign direct investment (FDI) in India soared from less than US$ 2 billion in 1991, when the country undertook major reforms to open up the economy to world markets, to almost US$ 39 billion in 2004 (UNCTAD online database). Currently, it is being discussed to deregulate FDI restrictions further, e.g., by allowing FDI in retail trade. Policymakers in India as well as external observers attach high expectations to FDI. If FDI can work wonders in China they it can even in India. The improved investment climate has not only resulted in more FDI inflows but also in higher GDP growth. The implicit assumption seems to be that higher FDI has caused higher growth. Policymakers in India should throw wide open the doors to FDI which is supposed to bring huge advantages with little or no downside.So far, the IMF and the World Bank has forecasted a 6.4 per cent growth rate in 2015, this cites renewed confidence in the market due to a series of economic reforms pursued by the new government.In 2013, India's growth rate was 5 per cent. On the other hand in China, growth is projected to remain at 7.1 per cent in 2015.

Measures taken by India Govt. and Reserve Bank to control Inflation

In this section, we explain the measures through which India has managed to control its inflation during the last year or so.

Reserve Bank

Monetary Policies

Monetary policy is mainly about adjusting the supply of money in the economy to achieve combination of inflation and output stabilization. Any change in money supply can affect the prices. In the short run the prices and wages may not adjust each other which leads to the decrease in aggregate demand and subsequently it affect the production of goods and services.

During recession, consumers do not spend as they would normally do and this results in the production of less goods. During this scenario, firms do not need as much man power and results in idling of the work force. This leads to the layoff of workers and companies stop investing in new capital ventures. Government at this time can modify the money supply in the economy to counter the situation which can lead to exactly opposite circumstances. But governments are usually careful in not overdoing the pumping of liquidity into the economy, which can lead to increase in prices. The increase in demand of goods will result in the increase in input costs and wages. People use their increased income to buy more goods which further increase the prices. Thus the governments and central banks use money supply in the economy as an effective tool to control the prices in the market.

The inflation in India (CPI) during January 2014 was 8.79, this came down to 5 during December 2014. The Reserve bank had been trying to reduce the inflation in India for quite long time but wasn’t successful. The current Reserve Bank Governor, Mr. Raghu Ram Rajan reckons it has been the monetary stability during the last 14 months or so, which has helped it bring down the inflation. The Reserve bank is well on its way to achieving its targeted 6 percent inflation in January 2016.

The Reserve bank of India has increased its bank rates 3 times since last September to absorb the excess liquidity in the system. By raising interest rates, the RBI causes banks to raise rates and thus lowers demand; firms do not borrow as much to invest when rates are higher and individuals stop buying durable goods against credit and, instead, turn to save. Reserve bank of India believes it’s the inflation India has to fight first which will lead to the stability of Rupee. The exchange rate stability is central to India’s business interests. RBI also believes it is not inhibiting India’s growth. They also believe that people’s ‘expectations’ also play a vital role in controlling the inflation, in the words of the RBI Governor, “If people believe we are serious about inflation, and their expectations of inflation start coming down, inflation will also come down.”

The RBI has also prepared a plan of action to control the food inflation in India. The food inflation has been mainly due to food production costs. There needs to be a shift in relative wages between other sectors as compared to Agriculture to keep it attractive. To control food inflation and to get strong food production the plans are to

i. Contain the rise in wages elsewhere so that relative wages in agriculture can rise without too much overall increase in wages.

ii. Contain any unwarranted rise in rural wages as well as the rise in other agricultural input costs (though not through subsidies) so that the farmer gets a higher return.

iii. Allow food prices to be determined by the market and use minimum support prices to provide only a lower level of support so that production decisions do not get distorted or the price wage spiral accentuated. This means limiting the pace of MSP increases going forward.

iv. Reduce the wedge between what the farmer gets and what is paid by the household by reducing the role, number, and monopoly power of middlemen (amend APMC Acts), as well as by improving logistics.

v. Improve farm productivity through technology extension, irrigation, etc.

Government Role

Fiscal Policies

To finance its fiscal deficit the Government borrows from Reserve Bank of India against its own securities. This is only a technical way of creating new money because the Government has to pay neither the rate of interest nor the original amount when it borrows from Reserve Bank of India against its own securities.

Budget deficit thus implies that Government incurs more expenditure on goods and services than its normal receipts from revenue and capital budgets. This excess expenditure by the Government financed by newly created money leads to the rise in incomes of the people. This causes the aggregate demand of the community to rise to a greater extent than the amount of newly created money through the operation of what Keynes called income multiplier.

The expansion in money supply by monetization of fiscal deficit leads to inflation in the economy by causing excess aggregate demand in the economy, especially when aggregate supply of output is inelastic. To some extent the creation of new money may not generate demand-pull inflation because if the aggregate output increases, especially of essential consumer goods such as food-grains, cloth, the extra demand arising out of newly created money would be matched by extra supply of output.

However, when there is too much resort to monetization of fiscal deficit, it will create excess of aggregate demand over aggregate supply. There is no wonder that this has contributed a good deal to the general rise in prices in the past and has been an important factor responsible for present inflation in the Indian economy.

To reduce fiscal deficits and keep deficit financing (which is now called monetization of fiscal deficit) within a safe limit, the Government can mobilize more resources through raising:(a) Taxes, both direct and indirect,

(b) Market borrowings, and

(c) Raising small savings such as receipts from Provident Funds.

National Saving Schemes (NSC and NSS) by offering suitable incentives. The Government borrows from the market through sales of its bonds which are generally purchased by banks insurance companies, mutual funds and corporate firms.

The increase in Government expenditure made possible by borrowing without being matched by extra taxation causes aggregate demand to rise not only by the increase in government expenditure but also by the multiplier effect of increase in Government expenditure. If in response to increase in aggregate demand, aggregate supply does not increase sufficiently due to capacity constraints to meet the rise in aggregate demand, the result is inflation is the economy.

Therefore, to check inflation the Government should try to reduce fiscal deficit. It can reduce fiscal deficit by curtailing its wasteful and inessential expenditure. In India, it is often argued that there is a large scope for pruning down non-plan expenditure on defense, police and General Administration and on subsidies being provided on food, fertilizers and exports.

Thus, both by greater resource mobilization on the one hand and pruning down of wasteful and inessential Government expenditure on the other, the fiscal deficit and consequently inflation can be checked. In its recommendation for India IMF has suggested that fiscal deficit in India should be reduced to 3 per cent of GDP if inflationary pressures are to be controlled.

How Inflation affects various sectors

Agriculture Sector

Inflation raises prices for farm inputs as well as farm products, resulting in uncertain effects on the current net incomes of farmers. Inflation may benefit people with flexible money incomes but not those whose money incomes are fixed. Farmers have flexible money incomes. Therefore, theoretically at least, they should benefit from an unanticipated increase in the rate of inflation. But this is not the case.

As inflation increases, prices paid by farmers for various inputs increase faster than the prices they receive for their products, thereby the terms of trade for farmers deteriorate as the rate of inflation rises. General inflation when accompanied by growth may be associated with a slight increase in the demand for farm output. However, increase is likely to be small due to the low-income elasticity of demand for farm output.

On the other hand, higher marketing margins due to imperfections in the agricultural markets, stirred up by higher wages and various other marketing costs, reduce the demand for farm output at the farm level. These opposing forces suggest that the net impact of inflation in the national economy on prices received by farmers is small in comparison to the impact on prices paid.

The impact of inflation on agriculture is multifaceted. Firstly, it raises the sector's costs of production through increased material input costs. Secondly, higher production costs may be shifted to consumers, but this possibility is limited by the competitive imports, thus reducing farmers' rate of return. The low current income from farming motivates farmers to seek higher

support prices and to extend price support policies to more commodities. Such policies result in further higher prices and higher rates of inflation. The high input prices lead farmers to take recourse to more credit, especially non-institutional credit for their farm operations which ultimately leads farmers into a debt-trap.

Automobile Industry

Inflation always has a negative effect on the car market. The development of the car market comes to a standstill when there is inflation in the market. The effect of inflation on car market is not at all encouraging and it badly affects every sector, which is associated with vehicle production and manufacturing. The hike in the rate of steel and fuel has resulted in a slower rate of development of the Indian automotive industry. One of the major effects of inflation is that the manufacturing of Indian cars has been hindered to a significant extent.

It has also been witnessed that major Indian vehicle manufacturers such as Tata Motors, Mahindra and Mahindra, Hyundai, Maruti Suzuki, and Honda Siel Motors are attempting their best to improve their manufacturing and sales of the vehicles amidst the situation where the stock market is showing a sluggish growth. It has also been seen because of inflation that sales of particular vehicles are being stimulated by the discounted rates that the car manufacturers are providing to the customers. Some of the vehicle makers have even resorted to offering exchange offers to the customers and some have launched competitive car financing rates. The effect of inflation has resulted in the hike of vehicle prices to the extent of 3%-4%, which sequentially is adequate for the necessity of meeting the hike of rates of raw materials for making an automobile.

The effect of inflation on car market has not only badly impacted the manufacturing and sales of Indian vehicles but also the vehicle dealers, employees, and vehicle financers. Surveys and studies have resulted in the conclusion that the vehicle market and the vehicle manufacturing industry in India experienced 8-9% slump due to inflation.

The effect of inflation on vehicle manufacturers have consequently affected the vehicle dealers in a manner where they are being forced to thrust the sales curve upward and maintain a high volume of profit. In this arrangement, the vehicle financers are compelled by both vehicle dealers and vehicle manufacturers to offer the customers a 100% financial assistance by lowering the interest rate of the loan.

On the whole, it has been observed that the car market in India (both passenger car market and commercial vehicles market) has witnessed a slump with the inflation badly hitting nearly every sector to which the Indian automobile market is closely associated.

Services Sector

In the short run inflation can be a good thing for services sector. People may continue to use the services inspite of inflation, but in the long run once the service charges increases the demand for services may come down and thus it will affect the revenues of the sector.

Conclusion

On the whole, inflation badly hits all the sectors in the long run and need to be reduced. The recent fiscal and monetary measures taken by the government and RBI has helped India reduce its current inflation. RBI recently reduced its rates by 25 basis points in January 2015 in order to boost the growth of industries, which will encourage the firms to make more capital investments thus leading to higher GDP growth.