Inflation Asnmt

8/8/2019 Inflation Asnmt

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THE OGRE OF INFLATION

CAUSES, SOLUTIONS AND

SIDE EFFECTS

SUBMITTED TO,

SIJI CYRIAC

SUBMITTED BY,

TEAM SCORPIO


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INFLATION:

Inflation is a process in which the price is rising at a rapid rate and

the money is losing its value. In the words of Gardner Ackley, Inflation

may be defined as a persistent and appreciable rise in general level of

average of prices. It may here denote that rising general level of price

doesnt mean that all prices are necessarily rising. Even during inflation,

the prices of some goods may remain relatively constant and a few

others actually falling. Inflation also does not mean that prices of goods

rise evenly or proportionately. Inflation is an upward movement in the

general (average) level of prices. In Pakistan, the general price level is

persistently rising since Partition of the Subcontinent. Prices remained

volatile during the decade of 1990s ranging form 5.7% to 13% mainly

because of declining economic growth, expansionary policies, output set

backs, higher taxes and a depreciation of Pakistani rupee. The inflation

rate started declining form 1998 on ward due to improved supply

position of goods, strict budgetary measures. The inflation rate was

5.7% in 1998-99. It was brought down to 3.6% in 1992-2000 and further

to 3.1% in 2002-03. The inflation rate based on the CPI (Consumer

Price Index) has averaged 4.6% during 2003-04. The slight rise in prices

was the year 2004-05 mainly due to rise in the price of wheat and an

increase in the international oil price.


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CAUSES OF INFLATION:

The causes of inflation are generally grouped under two main heads

(a) Demand Pull Inflation (b) Cost Push Inflation.

A. Demand Pull Inflation:

Demand pull inflation occurs when aggregate demand for goods

exceeds aggregate supply of goods at current prices, thus leading to an

increase in the price level. The factors of which bring about increase in

aggregate demand for goods or rise in the general level of prices are

grouped under two separate heads; (i) Factors operating on demand side

(ii) Factors operating on the supply side.

(a) Factors operating on the demand side : These are the factors

which bring continuous rise in the general price level.

(1) Increase in money supply: An increase in money supply leads to an

increase in money income. The increase in money income raises the

aggregate demand for goods and services in the country. The supply of

money increases when the govt. resorts to deficit financing or the

commercial banks expand credit. When too much money chases too few

goods, the result is an increase in general price level.

(2) Increase in Government expenditure : If there is increase in govt.

expenditure due to adoption of development and welfare activities of the

country has to flight a war, it causes as increase in govt. expenditure

which leads to increase in aggregate demand for goods and services and

hence the price level goes up.


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(3) Increase in private expenditure: A continuous increase in

consumption and investment expenditure in the private sector raises the

demand for goods and services and leads to inflationary rise in prices.

(4) Increase in population: The rapid rising population exerts pressure

on the demand for goods and services. If the supply of goods and

services fail to match with the demand, the general price level moves

upward.

(5) Black money: The money generated through smuggling, tax evasion

etc. raises the demand for luxury and other goods. Hence black money is

also one of the causes in raising the aggregate demand for goods and a

rise in general price level.

(b) Factors causing decrease in supply of goods: If the increase in

aggregate demand for goods and services is matched by an increase in

the supply of goods, it will not cause inflationary situation. When the

aggregate supply of goods is at a slower pace than the growth in

aggregate demand, it then causes inflationary rise in prices.

The following factors are identified for relatively slower growth in the

supply of goods.

(i) Lagging agricultural & industrial production: The increase in

population, incomes, employment and urbanization exert pressure on the

demand for goods and services. However, the agricultural and industrial

production grows at a slower pace, due to shortage of essential inputs

like fertilizers, water, cement, iron etc. When aggregate demand for


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goods and services exceeds the aggregate supply of it, it causes a rise in

the prices of agricultural and industrial goods.

(ii) Inadequate infrastructure facilities: If, in a country there is

shortage of power,transport and communication facilities are slow and

inefficient, it results in the slowing down of overall production of goods.

When the supply of goods falls short of demand, the prices go up in the

country.

(iii) Long gestation period: If the time lag between investment and the

production of goods is long, the shortage of goods will arise. This will

also contribute to inflationary pressure in the economy.

B. Cost Push Inflation:

Cost push inflation occurs when there is an increase in the cost of

production of goods and is not associated with excess demand. The main

causes of cost push inflation are:

(1) Increase in money wage rate: The wage push inflation occurs when

strong labour unions manage to press for wage increases in excess of

labour productivity. Unit cost of production is thereby raised. The rise in

cost of production exerts pressure on sellers to increase prices of goods

so as to get profit margin.

(2) Profit push inflation: If the producers of certain commodities have

monopoly or near monopoly power in the market, they fix up higher

profit margins arbitrarily without any increase in other elements of cost.

When a few powerful firms increase the profit margins, the smaller


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firms also tend to mark up their profit margins. The higher profit

margins, thus, inflate the price level.

(3) Material push inflation: If there is increase in the prices of some

basic materials such as gas, steel, chemicals, oil etc which are used

directly or indirectly in almost all industries, it causes an increase in the

cost of production and hence in the general price level.

(4) Higher taxes: If the government levies new taxes and raises the

rates of old taxes the producers generally shift the burden of taxes on to

the consumers. The increases in the selling prices of the commodities

push up the inflationary trend in the economy.

(5) Import prices: If prices of imported goods increase, it also results in

the contribution of inflation.


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KINDS OF INFLATION:

Inflation is of different types. It is generally classified on the following

basis.

On the Basis of Rate of Inflation:

(i) Creeping Inflation: It is a situation in which the rise in general price

level is at a very slow rate over a period of time. Under creeping

inflation, the price level raises upto a rate of 2% per annum. A mild

inflation is generally considered a necessary condition of economic

growth.

(ii) Walking Inflation: Walking inflation is a marked increase in the

rate of inflation as compared to creeping inflation. The price rise is

around 5% annually.

(iii) Running Inflation: Under running inflation, the price increases is

about 8% to 10% per annum.

(iv) Galloping or Hyper Inflation: Galloping inflation is a full

inflation. Keynes calls it as the final stage of inflation. It is a stage of

inflation which starts after the level of full employment is reached. Here

price level rises very rapidly within a short period.

On the Basis of Degree of Control:

(i) Open Inflation: It is a stage when the rise in price level gets out of

control. Milton Friedman describes it as inflationary process in which

prices are permitted to rise without being suppressed by government

price control or similar measures.


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(ii) Suppressed Inflation: Under this type of inflation, the government

makes efforts to check and control the rise in price level through price

and rationing. When price level is suppressed by the above short term

measures, it results in many evils such black marketing, hoarding,

corruption & profiteering.

Inflation on the Basis of Causes:

(i) Demand Pull Inflation: Inflation caused by increase in aggregate

demand, not matched by aggregate supply of goods, resulting in rise of

general price level is called demand pull inflation. Demand pull inflation

to be simpler, occurs when the demand for goods and services in the

country is more than their supply. The effective demand for goods

increases due to many factors such as increase in money supply,

increase in the demand for goods by the government, increase in the

income of various factors of production etc. In short, the excessive

increase in the money supply causes inflationary conditions. Demand

pull inflation is generally characterized by shortage of goods and

shortage of workers.

(ii) Cost Push Inflation: Cost push inflation occurs when the increasing

cost of production pushes up the general price level. Cost pull inflation

occurs when the economy is below full employment with prices rising

even though there is no shortage of goods. Cost push inflation is the

result of increase in wage costs unaccompanied by corresponding


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increase in productivity, rise in import prices of goods, depreciation in

the external value of the currency, higher mark up etc, etc.

(iii) Profit Induced Inflation: Profit inflation is in fact categorized

under cost push inflation. When entrepreneur, due to their monopoly

position raise the profit margin on goods. It may cause profit push

inflation.

(iv) Budgetary Inflation: When the government of a country occurs the

deficits in the budgets through bank borrowing and creating new money

(Deficit Financing), the purchasing power of commodity increases

without a simultaneous increase in the production of goods. This leads

to rise in the general price level.

(v) Monetary Inflation: Milton Friedman is of the firm view that

inflation is always and anywhere a monetary phenomenon. According to

him, inflation is caused by a too rapid increase in the money supply and

by nothing else.

(vi) Multi Casual Inflation: Inflation has a number of causes. It may be

caused by increase in money supply, excessive wage demands, excess

aggregate demand for goods, shortage of goods etc. The chief cause of

inflation in one year may not be in the next year. Since inflation is multi

causal, therefore a variety of policy measures are needed to deal with it.

On the Basis of Employment:

(i) Partial Inflation: According to J.M. Keynes, takes place when the

general price level rises partly due to an increase in the cost of


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production of goods and partly due to rise in supply of money before the

full employment stage is reached.

(ii) Full Inflation: Full inflation prevails when the economy has reached

the level of full employment. Any increase in money supply beyond full

employment. It is also called as real inflation.

Anticipated versus Unanticipated Inflation:

(i) Anticipated inflation is the rate of inflation which majority of the

individual believes will occur. When the rate of inflation (say 6%) turns

out to be same (6%) we are then in a situation of fully anticipated

inflation.

(ii) Unanticipated inflation is that which comes as a surprise to majority

of individuals. It can be higher or lower than the rate of anticipated

inflation.


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SIDE EFFECTS OF INFLATION

I have this strong hunch that the galloping inflation is indirectly going to

regulate the life of middle class for the better. My logic is as follows.

Increase of petrol price; the increase in petrol price is going to force

people to use less of personal conveyance and depend more on public

transport and thus walk upto the bus stands or the metro. This will

improve the health of the individual. The youth will have less of pocket

money and also have to pay more for the petrol of their two wheelers, so

less of zipping around and leading more disciplined life.

Increase of prices of vegetables, fish meat etc; no more bulk purchase

of vegetables. So walk every day to the daily market for fresh vegetable

and walk longer for cheaper stuff. The increase of cost of mutton means

eating less of red meat and thus reducing the chances of heart attack.

Costlier restaurant food; so less of eating out and thus more of home

cooked food. Even the eating of junk food will come down as

dispensable money in the pocket of the school and college going kids

will be less.

Costlier edible oil; those deep fried foods will go out slowly. People

will adopt more of pan fried kind of food with less oil. Indians are often

accused of going fat because of eating more of fried foods. So the

chances of putting on weight will decrease, we will have healthier

population.


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Cost of electricity going up; People will try to use less of air

conditioning in the homes. This again will indirectly help them to

become healthy in natural environment and also less load on the

electricity grids.

Increase of plane fare; this will really help those neglected nana nanis,

now papas and mamas can not make those Goa trips during holidays,

instead they will take them to their villages to visit nana , nanis like old

time and thus those poor souls will get the much needed attention in the

twilight of their lives.

Less of pocket money to the kids; this will hit those malls and

multiplexes. The number of pop corn chewing youth going for those

multiplexes will reduce as they will opt for those good old cinema halls

which show movies at less than half the price.

Well folks on the whole this inflation is going to have more

multidimensional effects as all of us in our own way are going to prune

our household budget to match the income, but the effect on quality of

life may improve as time spent in door is going to increase.


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REMEDIES OF INFLATION

The first panacea for a mismanagement nation is inflation of the

currency. The second is war. Both bring a permanent ruin. They both are

the refuge of political and economic opportunities. (Ernest Hemingway).

To avoid political unrest and harmful, social and economic effects on

the economy, it is the main objective of every government to take

appropriate measures to control inflation. The main measures which are

used to control inflation are (1) MONETARY POLICY (2) FISCAL

POLICY and other measures:

1. Monetary Policy

Monetary policy is a policy that influences the economy through

changes in the money supply and available credit. Monetary policy is

adopted by central bank of a country. The various monetary measures

which are used to control inflation are grouped under two heads (a)

Quantitative controls (b) Qualitative controls. They are (1) Open market

operations (2) Variation in bank rates (3) Credit rationing (4) Varying

reserve requirements (5) Varying margin requirements (6) Consumer

credit regulations.

2. Fiscal Policy

Fiscal policy is the deliberate change in either government spending or

taxes to stimulate or slow down the economy. It is the budgetary policy


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of the government relating to taxes public expenditure, public borrowing

and deficit financing. Fiscal policy is based upon demand management

i.e, raising or lowering the level of aggregate demand by controlling

various expenditures, government expenditure, consumption

expenditure and investment expenditure. The main fiscal measures are:

oChanges in taxation If the Govt: of a country brings about changes in

tax rates, it can help stabilization of prices in the country. For example.

A decrease in taxes relates increases disposable income in relation to

national income hence, consumption rises at every level of national

income. With the increase in aggregate demand for goods, the

employment goes up in the country. A rise in tax rates has the opposite

effect. A rise in taxes causes a decrease in disposable income, creates a

larger budget deficit and brings relief from inflation.

oChanges in Govt. Expenditure

If inflation is at or above the level of full employment in the country, the

government can bring down price level by curtailing its own

unproductive expenditure.

oPublic borrowing

Public borrowing is another effective method of controlling inflation.

Public borrowing reduces the aggregate demand for goods and hence

price level

oBalanced budget Changes

A balanced budget decrease has a mild contractionary effect on national

income and hence on bringing down the price level.


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oControl of deficit financing

For financing the budget deficit, the govt. often resorts to deficit

financing . the bank borrowing and printing of new notes increases the

money supply in the country and pushes up the price level. Deficit

financing therefore, should be avoided to control inflation.

Others Measures:

Apart from fiscal and monetary measures, the other measures which are

helpful in controlling inflation are;

(a)Price support programme.

(b)Provision subsidies.

(c)Arrangements of easy availability of goods on hire purchase to

stimulatedemand.

(d) Imposing direct control on prices of essential items.

(e)Rationing of essential consumer goods in case of acute emergency

holding ofFriday and Sunday markets.

Since 1950s the control of inflation has become the chief objective of

both developing and developed countries of the world. The government

therefore take monetary, fiscal and other measures to combat inflation.

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Inflation Asnmt

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