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IMPACT OF INFLATION ON CAPITAL MARKET
SYNOPSIS
1. Introduction of Inflation.
1.1 Inflation: Definition.
1.2 How to measure Inflation?
1.3 Features of Inflation.
1.4 Types of Inflation.
- Creeping Inflation.
--Wage inflation.
- Walking Inflation.
- Running Inflation.
- Galloping or Hyper-Inflation.
- Cost-Push Inflation.
- Demand-pull Inflation.
- Built-in Inflation.
- Chronic Inflation.
-Pricing power inflation.
1.5 Others Terms related to Inflation
- Deflation
- Disinflation
- Inflationary spikes
- Reflation
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1.6 Causes of Inflation
2. Trace the Effects of Inflation
2.1 Economic Effects of Inflation
2.1.1 Effects on production
2.1.2 Effects of Inflation on Income Distribution.
2.1.3. Effect of Inflation Interest rate.
2.1.4. Effects of Inflation on Globalisation.
2.1.5. Effects of inflation on exchange rate.
2.1.6. Effects on Manufacturers.
2.1.7. Effects of inflation on monetary policy.
2.1.8. Effects of inflation on investment.
2.1.9. Effects of inflation on stock market.
3. Measures to Control Inflation
1) Monetary Measures
2) Fiscal Measures
3) Other Non-monetary Measures
4. Price Rise still pinching Common Man's Poker
5. Tackling Inflation
6. Measures of Inflation
7. Inflation & India (WPI)
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8. Indian Scenario- Reasons for inflation in India
- Inflation Pressure over the Last Few Months
- Inflation in India and other Developed Countries
- Inflation during 1980's and 1990's
- Global Inflation A Comparison With India
9. Issues in Measuring Inflation
10. An Example of How Inflation Can Be Dangerous (Case)
11. Reserve Bank of India- Introduction
- Functions of Reserve Bank of India
- Role of RBI
- Control Measures of RBI
- Monetary Policy
- Monetary & Credit Policy
12. Conclusion.
InflationOR
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SYNOPSIS OF PROJECT
1) Introduction of Inflation
Inflation: Definition
How to measure Inflation?
Features of Inflation
2)Types of Inflation
Creeping Inflation
Walking Inflation
Running Inflation
Galloping or Hyper-Inflation
Cost-Push Inflation
Demand-pull Inflation
Built-in Inflation
Chronic Inflation
Pricing Power Inflation
3)Others Terms related to Inflation
Deflation
Disinflation
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Inflationary spikes
Reflation
4)Causes of Inflation
Monetary Factors
Non-monetary Factors
Structural Factors
5)Trace the Effects of Inflation Economic Effects of Inflation
Effects on production
Effects of Inflation on Income Distribution
Effect Of Inflation on Consumption And Welfare
EffeSScts of Inflation on Foreign Trade
Social and Political Effects
Effects On Manufacturers
6) Measures to Control Inflation Monetary Measures
Other Non-monetary Measures
Price Rise still pinching Common Man's Poker
Tackling Inflation
Measures of Inflation
Inflation & India (WPI)
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7) Indian Scenario Reasons for inflation in India
Inflation Pressure over the Last Few Months
Inflation in India and other Developed Countries
Inflation during 1980's and 1990's
Global Inflation A Comparison With India
8) Issues in Measuring Inflation An Example Of How Inflation Can Be Dangerous (Case)
9)Reserve Bank of India Introduction
Functions of Reserve Bank of India
Role of RBI
Control Measures of RBI
Monetary Policy
Monetary & Credit Policy
10)Conclusion
Inflation can be defined
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PROJECT REPORTON
IMPACT OF INFLATION ON CAPITAL MARKET
BACHELOR OF COMMERCE
FINANCIAL MARKETS
SEMESTER-V
SUBMITTED TO:
UNIVERSITY OF MUMBAI
In partial fulfillment requirements For the Award of degree of
Bachelor of Commerce Financial Markets.
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PREPARED By
LUND JAI .H.
ROLL NO:-04
UNDER GUIDANCE OF PROF.POOJA.NAGPAL
SMT. CHANDIBAI HIMATHMAL MANSUKHANI COLLEGE
ULHASNAGAR 3
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ACKNOWLEDGEMENT
A great teacher is not simple one who imparts knowledge to his student, but
one who awakens their interest in it & makes them eager to pursue it for
themselves.
This idiom without doubt, fit with PROF.POOJA NAGPAL who has been my
teacher, guide & mentor. She widened the sagacity of confidence in me for
affecting this project work from the bottom of my heart; I thank her for her
precious time that she spent for me.
It is a matter of utmost pleasure to express my indebtedness & deep sense
of gratitude, to various persons who extended their maximum help to supply
the necessary information for the present theses that became available on
account of the most selfless co-operation.
I am grateful to my parents & friends who encouraged & inspired me at
every stage of present work by providing immeasurable love affection care &
moral support.
Above all, my sincere & heartfelt thanks to almighty god who has always,
throughout the preparation of this project reports.
LUND JAI .H.
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DECLARATION
I, LUND JAI .H. student of B.COM FINANCIAL MARKETS semester (v) (2010-2011)
hereby declared that I have completed project on IMPACT OF INFLATION ON
CAPITAL MARKET
The information submitted is true and original to the best of my knowledge.
Signature of student
(LUND JAI .H.)
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OBJECTIVES
The project on IMPACT OF INFLATION ON CAPITAL MARKET has been
prepared with the following objectives:-
y To study the significance of various INFLATION towards the conuntry.
y To analyze various types of inflation available in the country.
y To analyze effects associated with inflation.
y To study various causes of inflation.
y To gain practical knowledge relating to whole price index.
y To suggest some of the remedies to control inflation.
y To co-operate with govt. so as to develop the economy.
y To analysis different policies and reports of reserve bank of india.
y To draw a conclusion and suggestions based on the analysis and
experiences.
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Chapter: - 01
After completing this chapter you will come know about:-
Inflation: Definition
How to measure Inflation?
Features of Inflation
01 INTRODUCTION
In todays complex business environment, making capital budgeting decisions are
Among the most important and multifaceted of all management decisions as it represents
Major commitments of companys resources and have serious consequences on the Profitability
and financial stability of a company. It is important to evaluate the proposals rationally with
respect to both the economic feasibility of individual projects and the relative net benefits of
alternative and mutually exclusive projects.
It has inspired many research scholars and is primarily concerned with sizable investments in
long-term assets, with long-term life. The growing of business brings stiff competition which
requires a proper evaluation and weightage on capital budgeting appraisal issues viz. differingproject life cycle, impact of inflation, analysis and allowance for risk. Therefore financial
managers must consider these issues carefully when making capital budgeting decisions.
Inflation is one of the important parameters that govern the financial issues on capital budgeting
decisions. Managers evaluate the estimated future returns of competing investment alternatives.
Some of the alternatives considered may involve more risk than others. For example, one
Alternative may fairly assure future cash flows, whereas another may have a chance of yielding
higher cash flows but May also result in lower returns. It is because, apart from other Things,
inflation plays a vital role on capital budgeting decisions and is a common fact of life All over
the world. Inflation is a common problem faced by every finance manager which complicates the
practical investment decision making than others. Most of the managers are concerned about the
effects of inflation on the projects profitability. Though a double digit Rate of inflation is a
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common feature in developing countries like India; the manager should consider this factor
carefully while taking such decisions. In practice, the managers do recognize that inflation exists
but rarely incorporate Inflation in the analysis of capital budgeting, because it is assumed that
with inflation, both net revenues and the project cost will rise proportionately, therefore it will
not have much impact.
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Meaning:-
Inflation (increase in money supply) increases the prices of goods because through inflation, the
value of the currency goes down. It practically debases the currency. Imagine rare baseball cards.
They have high value. But if you create more baseball cards, its value will go down as it is easier
for people to get these baseball cards which are not so rare anymore.
Inflation (increase in money supply) happens when central banks print money out of thin air
(through injection of artificial credit, artificially lower interest rates, etc.). This is the reason why
governments like to get out of the gold standard or any type of commodity based currency
because they could inflate (increase the money supply) anytime they want. If a currency is
backed by gold or any commodity, it prevents the government from artificially inflating the
currency as the supply of money is based on the supply of what it is backed by (i.e., gold, silver).
Inflation (increase in money supply), aside from its effect on prices, also affects people in
another way. Inflation (increase in money supply) only benefits the first group of people who
receive the newly printed money. The people who get the money first benefits because they get
to spend the newly printed money during the time when prices has not gone up yet as the newly
printed money hasn't deeply circulated the market. Once the money trickles down to theeconomy, more money is now available for spending, which debases the currency thus jacking
up the prices of goods. Prices of goods increase because more money is now in circulation which
was printed out of thin air. The value of the currency is now lower than before. Just like baseball
cards.
On the other hand, the people who don't get the money first will then hurt because the prices of
goods go up even before their salaries go up. So they will be spending more money for higher
priced goods for the same level of income before they even get a salary increase.
So basically, inflation is not an increase in prices of goods. Inflation is the increase in money
supply. The increase in prices of goods is a consequence of inflation. Now, I would say that the
common reason for inflation (increase in money supply) is the central bank's "printing press".
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Definitions:-
y According to Crowther, Inflation is a state in which the value of money is failing,
i.e., prices is rising.
y According to Pigou, Inflation takes place when money income is expanding
relatively to the output of work done by the productive agents for whom it is the payment.
y The term "inflation" originally referred to increases in the amount of money in
circulation, and some economists still use the word in this way. However, most economists
today use the term "inflation" to refer to a rise in the price level. An increase in the money
supply may be called monetary inflation, to distinguish it from rising prices, which may
also for clarity be called 'price inflation'.Economists generally agree that in the long run,
inflation is caused by increases in the money supply. However, in the short and medium
term, inflation is largely dependent on supply and demand pressures in the economy.
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Features:-
The quantity of money is increasing but the production is static and not increasing.
The quantity of money is stable but the production is declining.
If the quantity of money is declining and the production is also declining but decline
in production is higher than the decline in the quantity of money.
If the quantity of money is increasing and the volume of production is declining.
If the quantity of money is in excess of demand or requirements.
If the quantity of money as well as production is increasing but rate of increase in
production is lesser than the rate of increase in the quantity of money.
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Chapter: - 02
After completing this chapter you will come know about:-
Creeping Inflation
Walking Inflation
Running Inflation
Galloping or Hyper-Inflation
Cost-Push Inflation
Demand-pull Inflation
Built-in Inflation
Chronic Inflation
Pricing Power Inflation
Types of Inflation:-
Creeping Inflation:-
When prices are gently rising, it is referred as Creeping Inflation. It is the mildest form of
inflation and also known as a Mild Inflation orLow Inflation. According to R.P. Kent, when
prices rise by not more than (up to) 3% per annum (year), it is called Creeping Inflation.
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.
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Cost Push Inflation:-
Cost Push Inflation occurs when there is an increase in the cost of production for firms
causing Aggregate Supply to shift to the left. Cost push inflation could be caused by rising
energy and commodity prices.
Wage Push Inflation:-
Rising wages tend to cause inflation. In effect this is a combination of demand pull and cost
push inflation. Rising wages increase cost for firms and so these are passed onto consumers in
the form of higher prices. Also rising wages give consumers greater disposable income and
therefore cause increased consumption and AD. In the 1970s, trades unions were powerful in the
UK. This helped cause rising nominal wages; this was a significant factor in causing inflation
Walking Inflation:-
When the rate of rising prices is more than the Creeping Inflation, it is known as Walking
Inflation.When prices rise by more than 3% but less than 10% per annum (i.e between 3% and
10% per annum), it is called as Walking Inflation. According to some economists, walkinginflation must be taken seriously as it gives a cautionary signal for the occurrence of Running
inflation. Furthermore, if walking inflation is not checked in due time it can eventually result in
Galloping inflation.
Chronic Inflation:-
If creeping inflation persist (continues to increase) for a longer period of time then it is often called as
Chronic or Secular Inflation. Chronic Creeping Inflation can be either Continuous (which remains
consistent without any downward movement) or Intermittent (which occurs at regular intervals). It is
called chronic because if an inflation rate continues to grow for a longer period without any downturn,
then it possibly leads to Hyperinflation.
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Running Inflation:-
A rapid acceleration in the rate of rising prices is referred as Running Inflation.When prices rise by
more than 10% per annum, running inflation occurs. Though economists have not suggested a fixed range
for measuring running inflation, we may consider price rise 10% to 20% per annum (double digit inflationrate) as a running inflation.
Galloping Inflation:-
According to Prof. Samuelson, if prices rise by double or triple digit inflation rates like 30% or 400%or 999% per annum, then the situation can be termed as Galloping Inflation. When prices rise by more
than 20% but less than 1000% per annum 20% to 1000% per annum), galloping inflation occurs. It is also
referred as jumping inflation. India has been witnessing galloping inflation since the second five year plan
period.
Hyperinflation:-
Hyperinflation refers to a situation where the prices rise at an alarming high rate. The prices rise so
fast that it becomes very difficult to measure its magnitude. However, in quantitative terms, when prices
rise above 1000% per annum (quadruple or four digit inflation rate), it is termed as Hyperinflation.
During a worst case scenario of hyperinflation, value of national currency (money) of an affected country
reduces almost to zero. Paper money becomes worthless and people start trading either in gold and silver
or sometimes even use the old barter system of commerce. Two worst examples of hyperinflation
recorded in world history are of those experienced by Hungary in year 1946 and Zimbabwe during 2004-
2009 under Robert Mugabe regime.
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Build-In Inflation:-
Vicious cycle of Build-in inflation is induced by adaptive expectations of workers or employees who
try to keep their wages or salaries high in anticipation of inflation. Employers and Organizations raise the
prices of their respective goods and services in anticipation of the workers or employees' demands. Thisoverall builds a vicious cycle of rising wages followed by an increase in general prices of commodities.
This cycle, if continues, keeps on accumulating inflation at each round turn and thereby results into what
is called as Build-in inflation.
Sect oral Inflation:-
It occurs when there is a rise in the prices of goods and services produced by certain sector of the
industries. For instance, if prices of crude oil increase then it will also affect all other sectors (like
aviation, road transportation, etc.) which are directly related to the oil industry. For e.g. If oil prices are
hiked, air ticket fares and road transportation cost will increase.
Pricing Power Inflation:-
It is often referred as Administered Price inflation. It occurs when industries and business
houses increase the price of their goods and services with an objective to boost their profit
margins. It does not occur during a financial crisis and economic depression, and is not seen
when there is a downturn in the economy. As Oligopolies have the ability to set prices of their
goods and services it is also called as Oligopolistic Inflation.
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Chapter: - 03After completing this chapter you will come know about:-
Others Terms related to Inflation
Deflation
Disinflation
Inflationary spikes
Reflation
Deflation
Concept of deflation:-
A decline in general price levels, often caused by a reduction in the supply of money or
credit. Deflation can also be brought about by direct contractions in spending, either in the form
of a reduction in government spending, personal spending or investment spending. Deflation has
often had the side effect of increasing unemployment in an economy, since the process often
leads to a lower level of demand in the economy opposite of inflation.
In economics, deflation is a decrease in the general price level of goods and services.
Deflation occurs when the inflation rate falls below 0% (a negative inflation rate). This should
not be confused with disinflation, a slow-down in the inflation rate (i.e. when inflation declines
to lower levels). Inflation reduces the real value of money over time; conversely, deflation
increases the real value of money the currency of a national or regional economy. This allows
one to buy more goods with the same amount of money over time.
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Concept of Disinflation:-
Disinflation is a decrease in the rate of inflation a slowdown in the rate of increase of the
general price level of goods and services in a nation's gross domestic product over time. It is the
opposite of reflation.If the inflation rate is not very high to start with, disinflation can lead to
deflation decreases in the general price level of goods and services. For example if the annual
inflation rate one month is 5% and it is 4% the following month, prices disinflated by 1% but are
still increasing at a 4% annual rate. If the current rate is 1% and it is the -2% the following
month, prices disinflated by 3% and are decreasing at a 2% annual rate.
There is widespread consensus among economists that inflation is caused by increases in the
supply of money available for use in a nation's economy. Inflation can also occur when the
economy 'overheats' because of excess aggregate demand (this is called demand-pull inflation).
The causes of disinflation are the opposite, either a decrease in the growth rate of the money
supply, or a business cycle contraction (recession). During a recession, competition among
businesses for customers becomes more intense, and so retailers are no longer able to pass on
higher prices to their customers. In contrast, deflation occurs when prices are actually dropping.
Concept of Inflationary Spikes:-
Inflationary spikes` occur when a particular section of the economy experiences a sudden
price rise possibly due to external factors. For example: If a large amount of crop is destroyed,
the value of the remaining crop will rise sharply.
Inflationary spikes occur when a particular section of the economy experiences a sudden price
rise possibly due to external factors. For example: If a large amount of crop is destroyed, the
value of the remaining crop will rise sharply. This will distort the overall measure of inflation
within the economy (Headline inflation). Core inflation seeks to avoid the influence of thesespikes by excluding areas of the economy such as food and energy which may be susceptible to
such shocks.
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Concept of Reflation:-
A fiscal or monetary policy, designed to expand a country's output and curb the effects of
deflation. Reflation policies can include reducing taxes, changing the money supply and
lowering interest rates.
The term "reflation" is also used to describe the first phase of economic recovery after a period
of contraction.
Reflation policy has been used by American governments, to try and restart failed business
expansions since the early 1600s. Although almost every government tries in some form or
another to avoid the collapse of an economy after a recent boom, none have ever succeeded in
being able to avoid the contraction phase of the business cycle. Many academics actually believe
government agitation only delays the recovery and worsens the effects.
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Chapter: - 04
After completing this chapter you will come know about:-
Causes of inflation:-
Over- Expansion of Money Supply: -
Many a times a remarkable degree of correlation between the increase in money and rise
in the price level may be observed. The Central Bank (Indias RBI) should maintain a
balance between money supply and production and supply of goods and services in the
economy. Money supply exceeds the availability of goods and services in the economy, it
would lead to inflation.
Increase in Population:-
Increase in population leads to increased demand for goods and services. If supply of
commodities is short, increased demand will lead to increase in price and inflation.
Expansion of Bank Credit: -
Rapid expansion of bank credit is also responsible for the inflationary trend in a country.
Deficit Financing: -
Deficit financing means spending more than revenue. In this case government of India
accepts more amount of money from the Reserve Bank India (RBI) to spend for
undertaking public projects and only the government of India can practice deficit
financing in India. The high doses of deficit financing which may cause reckless
spending, may also contribute to the growth of the inflationary spiral in a country.
High Indirect Taxes: -
Incidence of high commodity taxation, prices tend to rise on account of high excise duties
imposed by the Government on raw materials and essentials.
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Black Money: -
It is widely condemned that black money in the hands of tax evaders and black marketers
as an important source of inflation in a country. Black money encourages lavish
spending, which causes excess demand and a rise in prices.
Poor Performance of Farm Sector:-
If agricultural production especially food grains production is very low, it would lead to
shortage of food grains, will lead to inflation.
Other reasons :-
Other reasons include the following:
1) Capital bottleneck, entrepreneurial bottlenecks, infrastructural bottlenecks and foreign
exchange bottlenecks.
2)When the government of a country print money in excess, prices increase to keep up with
the increase in currency, leading to inflation.
3) Increase in production and labor costs, have a direct impact on the price of the final
product, resulting in inflation.
4) When countries borrow money, they have to cope with the interest burden. This interest
burden results in inflation.
5) High taxes on consumer products, can also lead to inflation.
6) Demands pull inflation, wherein the economy demands more goods and services than
what is produced.
7)
Cost push inflation or supply shock inflation, wherein non availability of a commoditywould lead to increase in prices.
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Chapter: - 05
After completing this chapter you will come know about:-
IMPACT OF INFLATION:-Problems of inflation
Effects on production.
Effects of Inflation on Income Distribution.
Effect of Inflation Interest rate.
Effects of Inflation on Globalisation.
Effects of inflation on exchange rate.
Effects on Manufacturers.
Effects of inflation on monetary policy.
Effects of inflation on investment.
Effects of inflation on stock market.
Introduction
Inflation has a positive impact and negative effects, depending on whether or not severe
inflation. If inflation is mild, it has a positive influence in the sense to stimulate the economy
better that is to increase national income and get people excited to work, save and invest.
Conversely, in times of severe inflation, which in the event of uncontrolled inflation
(hyperinflation), the economic situation became chaotic and felt sluggish economy. People are
not excited about working, saving, or make investment and production because prices are rising
rapidly. The recipients of fixed incomes such as civil servants or private employees and workers
will also be overwhelmed bear and keep up the price so that their lives become increasingly
degenerate and collapsed from time to time.
For people who have a fixed income, inflation is very detrimental. We take the example of a
retired civil servant in 1990. In 1990, his pension is adequate to meet the necessities of life, but
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in the year 2003-or thirteen years later, the purchasing power of money may be only a half. This
means that retirement money is no longer sufficient to meet their needs. Conversely, people who
rely on income based benefits, such as businessmen, not impaired by the existence of inflation.
So it is with employees who work in companies with salaries following the rate of inflation.
Inflation also causes people reluctant to save because of the currency goes down. Indeed, savings
earn interest, but if the interest rate above inflation, the value of money is still declining. When
people are reluctant to save money, business and investment will be difficult to develop.
Because, to grow the business need of funds from bank savings obtained from the public.
For people who borrow money from banks (the debtor), inflation is beneficial, because at the
time of payment of debts to creditors, the value of money is lower than at the time of borrowing.
Instead, the lender or the lender will lose money because the value of money returns lower than
at the time of borrowing.
For producers, inflation can be beneficial if the income earned is higher than the increase in
production costs.When this happens, producers will be forced to double its production (usually
happens in big business). However, when inflation led to rising production costs and eventually
harming producers, then producers are reluctant to continue production. Manufacturers could
stop production for a while. In fact, if not able to follow the rate of inflation, the business may bebankrupt manufacturer (usually occurs in small businesses).
In general, inflation can result in reduced investment in a country, pushing up interest rates,
encouraging speculative investment, the failure of development, economic instability, balance of
payments deficits, and declining levels of life and community welfare.
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THE PROBLEMS DUE TO INFLATION WOULD BE:
When the balance between supply and demand goes out of control, consumers could
change their buying habits, forcing manufacturers to cut down production.
The mortgage crisis of 2007 in USA could best illustrate the ill effects of inflation.
Housing prices increases substantially from 2002 onwards, resulting in a dramatic
decrease in demand.
Inflation can create major problems in the economy. Price increase can worsen the
poverty affecting low income household,
Inflation creates economic uncertainty and is a dampener to the investment climate
slowing growth and finally it reduce savings and thereby consumption.
The producers would not be able to control the cost of raw material and labor and hence
the price of the final product. This could result in less profit or in some extreme case no
profit, forcing them out of business.
Manufacturers would not have an incentive to invest in new equipment and new
technology.
Uncertainty would force people to withdraw money from the bank and convert it into
product with long lasting value like gold, artifacts
It has been reported that the manufacturing capacity in India is running around 95 per cent,
which usually means it is running at full capacity. Therefore, when the price of manufactured
products is increasing, it means that demand is usually higher than supply and that is a clear case
of demand-pull inflation.
On the primary goods front, which consists of fruits, vegetables, food-grains etc, it is not that
straight-forward. It has certainly been all over the news that the prices of fruits and vegetables
are increasing and a trip to the supermarket or local grocery shop will testify to that. Although it
is a clear case of demand-pull inflation, on the other, it is also a bit of a supply shock when one
considers the fact that there is an abnormally high percentage of fruits and vegetables that goes to
waste because of the lack of cold-storage facilities. Some estimates say 50 per cent of produce
goes to waste and that is a conservative number.
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The fuel price hike is a straight example of cost push inflation. When OPEC (The Organization
of the Petroleum Exporting Countries) was formed, it squeezed the supply of oil and this caused
oil prices to rise, contributing to higher inflation. Since oil is used in every industry, a sharp rise
in the price of oil leads to an increase in the prices of all commodities.
The in depth problems due to inflation would be:
When the balance between supply and demand goes out of control, consumers could
change their buying habits, forcing manufacturers to cut down production.
Inflation can create major problems in the economy. Price increase can worsen the
poverty affecting low income household.
Inflation creates economic uncertainty and is a dampener to the investment climate
slowing growth and finally it reduce savings and thereby consumption.
The producers would not be able to control the cost of raw material and labor and hence
the price of the final product. This could result in less profit or in some extreme case no
profit, forcing them out of business.
Manufacturers would not have an incentive to invest in new equipment and new
technology.
Uncertainty would force people to withdraw money from the bank and convert it into
product with long lasting value like gold, artifacts.
The imbalances inflation has created in the Indian economy:-
It has created a new rich class in social and political lives who are corrupt themselves and
also corrupt the overall society.
The increased prices reduced the capacity to save and people preferred present
consumption to future consumption.
It has provided protection and subsides to industries which bred inefficiency.
It has lead to misallocation of resources due to distortion of relative prices and finally a
redistribution of wealth from the poor to the rich.
It disturbs balance of payments.
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Economic Effects of Inflation
Inflation and the economy of a country are closely related. The effect on the economy of any
country is not immediate or it does not affect the economy overnight. There is a cumulative
effect. Several such changes build up to bring about a big change. The economy of a country is
affected by inflation in a number of ways.
Inflation and the economy both influence all the major macroeconomic indicators of a country.
The various macroeconomic indicators include the following:
Gross domestic product or GDP
Producer price index (industrial) Consumer price indices
Industrial production
Capital Investment
Agricultural production
Export
Import
Demography
Debt
Inflation not only affects the macroeconomic indicators, it affects the living standards of the
people. As the percentage of inflation increases, the cost of all commodities also increases.
However, the same is not true for the salaries or the wages. It results in a mismatch of income
and expenses. As a result, the people are immensely impacted by these changes. The exchange
rates of all currencies also change. This in turn influences trade.When exchange rates are
affected, the interest rates cannot be far behind.
Inflation and its effect on economy is enormous. In other words, all events are interlinked and the
entire economic cycle gets upset. Inflation and its effect on economy may be of two types:
y Expected inflation
y Unexpected inflation
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Effect on production:-
During inflation producers try to minimize the risk. Hence a lot of production potential is
sacrificed. Goods that are more durable are produced more; as compared to goods that are less
durable. This alters the pattern of production. Inflation gives rise to more speculation and
hoarding, which is bad for the economy.
The basic knowledge about the market tends to lose its importance, and producers and
consumers have to update themselves constantly. Production and economic growth gets seriously
retarded, as the products, at high prices, may fail to find a buyer. Wrong anticipations and
misallocation of resources lead to loss of profit and growth.
Effect of Inflation on Income Distribution:-
Inflation redistributes income, because prices of all factors do not rise in the same proportion.
Since the effect of inflation on the incomes of different classes of earners varies, there are serious
social consequences. During inflation, the distributive share accruing to the profiteers increases
more then that of wage earners or fixed income earners, such as their renters class. All
producers, traders and speculators gain during inflation because of the emergence of windfall
profits which arise, because prices rise at a faster and greater rate than the cost of production;
wages, interest and rent do not increase rapidly, and are more or less fixed.
i) Debtors and creditors: Debtors generally gain and creditors lost during inflation. Gain
accrues to a debtor because he repays loans at a time when the purchasing power of money is
lower than when it was borrowed. The creditor, on the other hand, is a loser during inflation,
since he received, in effect, less in goods and services than he would have received in times of
low prices. Thus, borrowers who borrowed funds prior to inflation stand to gain by inflation, and
creditors who lent funds lose.
ii) Business community: Inflation is welcomed by entrepreneurs and businessmen because they
stand to profit by rising prices. They find that the value of their inventories and stock of goods is
rising in money terms. They also find that prices are rising faster than the costs of production, so
that their profit margin is greatly enhanced. The business community, therefore, gets
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supernormal profit during periods of inflation, and those profits continue to increase as long as
prices rise.
iii) Fixed income groups: Inflation hits wage earners and salaries people very hard. Although
wage earners, by the grace of trade unions, can chase galloping prices, they seldom win the race.
Since wages do not rise at the same rate, and at the same time, as the general price level, the cost
of living index rises, and the real income of the wage earner decreases. Moreover, in trying to
push up wages to sustain their real income wage earners bring about cost-push inflation, and in
the process worsen their position.
Those who depend exclusively on fixed salaries for a living are severally affected by inflation.
Among these people are teachers, clerks, government servants, pensioners and persons living on
past savings.
iv) Investors: Those who invest in debentures and fixed interest bearing securities, bonds, etc.
lose during inflation. However, investors in equities benefit because more dividend is yielded on
account of high profits made by joint stock companies during inflation.
v) Farmers: Farmers are benefited during inflation because of two factors.
a) The prices of farm products increase, and
b) Increase in the cost of production lags behind the rise in the prices.
Farmers who produce food grains and other highly inflation sensitive products are benefited the
most. Farmers in debts repayments repay their old debts along with the rate of interest as they get
profits due to rising prices. They are further benefited as debtors as they pay back lower
purchasing power to the creditors, inflation, thus provides double advantages to the farmers.
3) Other Effect: Inflation leads to a number of other effects which are discussed as under :
i) Government: Inflation affects the government in various ways. It helps the government in
financing its activities through inflationary finance. As the money income of the people
increases, the government collects that in the form of taxes on incomes and commodities. So the
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revenues of the government increase during rising prices. Moreover, the real burden of the public
debt decreases when prices are rising.
ii) Balance of payments: Inflation involves the sacrificing of the advantages of international
specialization and division of labor. It adversely affects the balance of payments of a country.
When prices rise more rapidly in the home country than in foreign countries, domestic products
become costlier compared to foreign products. This tends to increase imports and reduce exports,
thereby making the balance of payments unfavorable for the country.
iii) Exchange rate:When prices rise more rapidly in the home country than in foreign countries,
it lowers the exchange rate in relation to foreign currencies.
iv) Collapse of the monetary system: It hyperinflation persists and the value of money
continues to fall many times in a day, it ultimately leads to the collapse of the monetary system,
as happened in Germany after world war I.
v) Social: Inflation is socially harmful. By widening the gulf between the rich and the poor,
rising prices create discontentment among the masses. Pressed by the rising cost of living,
workers, resort to strikes which lead to loss in production. Lured by Profit, people resort to
hoarding, black-marketing, adulteration, manufacture of substandard commodities, speculation,
etc. Corruption spreads in every walk of life. All this reduces the efficiency of the economy.
vi) Political: Rising prices also encourage agitations and protests by political parties opposed to
the government. And if they gather momentum and become unhandy they may bring the
downfall of the government. Many government have been sacrificed at alter of inflation.
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Effect inflation On producers:-
The increase was the fourth in consecutive months since the index resumed its ascent in
December last year, and the rate was the highest in the 12-month period to March 2011.The high
annual rate of increase in prices received by domestic producers continues to reflect the
substantial year-on-year impact of utility prices, which were hiked sharply in June 2010
following demands by producers in the sector for price-adjustments.Producer inflation in the
utilities sector was 71.96% year-on-year, though the increase between February and March was a
marginal 0.01%. Mining and quarrying recorded inflation of 32.27%, while manufacturing
inflation was a lower 11.61%.
Government Statistician, Dr. Grace Bediako, disclosed that the highest monthly inflation of
4.83% was recorded in the mining and quarrying sector due mainly to higher prices for gold. The
month-on-month rate for all industries was 0.91%, she said.Compared to February, this was a
lower monthly increase, and given the considerably lopsided effect of utility prices on the index,
the increasing annual rate of producer price inflation may not portend a similar trajectory for
consumer inflation in the coming months.
March consumer inflation dipped marginally to 9.13% as stable food prices helped turn the tide
of increases that had been occasioned by January's petroleum price revisions. Yet, as a cost-of-
doing-business indicator, the persistently double-digit producer inflation figures support long-
standing concerns within industry about a costly business environment as domestic producers
contend with cheap imports, high financing costs and currency risks that threaten the stability of
raw-material prices.
Effect of inflation Interest Rate:-
Interest and inflation are key to investing decisions, since they have a direct impact on the
investment yield.When prices rise, the same unit of a currency is able to buy less. A sustained
deterioration in the purchasing power of money is called inflation. Investors aim to preserve the
value of theirmoney by opting for investments that generate yields higher than the rate ofinflation. In most developed economies, banks try to keep the interest rates onsavings accounts
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equal to the inflation rate. However when the inflationrate rises,companies or governmentsissuing debt instruments would need to lure investors with a higher interest rate.
The Relationship between Interest and Inflation
Inflation is an autonomous occurrence that is impacted by money supply in an economy. Central
governments use the interest rate to control money supply and, consequently, the inflation rate.
When interest rates are high, it becomes more expensive to borrow money and savings become
attractive.When interest rates are low, banks are able to lend more, resulting in an increased
supply of money.
Alteration in the rate of interest can be used to control inflation by controlling the supply of money in
the following ways:
A high interest rate influences spending patterns and shifts consumers and businesses
from borrowing to saving mode. This influences money supply.
A rise in interest rates boosts the return on savings in building societies and banks. Low
interest rates encourage investments in shares. Thus, the rate of interest can impact the
holding of particular assets.
A rise in the interest rate in a particular country fuels the inflow of funds. Investors with
funds in other countries now see investment in this country as a more profitable option
than before
Inflation and Interest Rates: Effect on the Time Value of Money
Inflation has a significant impact on the time value of money (TVM). Changes in the inflation
rate (whether anticipated or actual) result in changes in the rates of interest. Banks and
companies anticipate the erosion of the value of money due to inflation over the term of the debt
instruments they offer. To compensate for this loss, they increase the interest rates.
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The central bank of a country alters interest rates with the broader purpose of stabilizing the
national economy. Investors need to keep a close watch on interest and inflation to ensure that
the value of their money increases over time.
Effect of inflation Exchange Rate:-
Inflation and exchange rates, both determine, if a nation is likely to be economically stable or
not. For several years, exchange rates have caused much debate and different opinions were
expressed with regard to exchange rates.
Inflation and its effects on exchange rates can also be ascertained from the following facts. In
earlier days, it was suggested by a majority of the economists to peg a particular currency or todollarize currency of a country. Nations (emerging countries) were used to having a fixed type of
exchange rate. Every effort was made to keep the exchange rate fixed because a floating
exchange rate was feared to cause inconvenience in trading.With the advent of the concept of
inflation targeting and exchange rates, which are flexible, the scenario has changed. More and
more countries are moving away from the fixed exchange rates. This transition is taking place,
when most of the nations are adopting inflation targeting as a means of conducting various
monetary policies. In many countries, the nominal exchange rate was used as a means to bring
down inflation.
Inflation and exchange rates- value of currency
The exchange rates are essential macroeconomic variables. It affects inflation, trade (imports and
exports) and various other economic activities of a nation. If the rate of inflation remains low for
a considerable period of time, the value of currency rises. This occurs due to increase in the
purchasing power. Switzerland, Japan and Germany were three countries, the inflation rates of,
which were low during the late twentieth century. Other countries to follow suit were Canada
and United States of America. The countries, having higher rates of inflation observed
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depreciation in their currency. On the other hand, countries with low rates of inflation did not
observe this trend at least for the time being.
In the event when a nation is aware of a possible rise in inflation, it can take measures
accordingly. Exchange rates may also be affected by the type of inflation prevailing in the
economy. Inflation may be:
Cost push inflation
Demand pull inflation
We discover a close association between inflation and exchange rates, which affect almost all
sectors of the economy.
Effect of inflation Globalization:-
Many economists hold different views about inflation and globalization. There are various
schools of thought.With regard to inflation and globalization, some economists say that
globalization encourages inflation, while few others express their view on the contrary.
Globalization has impacted inflation in different ways. Globalization basically means the
opening up of an economy.Whenever, the tariff barriers are lowered and trade barriers are removed, it means that goods
from other countries can be availed by residents of another country. There is extensive exchange
of goods and services. This is done by lowering the tariff and bringing down other obstacles.
What is to be seen next is the role played by inflation and globalization in the economy of a
country.
Inflation and globalization- Different views:-
Domestic inflation is impacted by many global factors. Owing to trade expansion there might be
domestic inflation. This happens because trade expansion depends to a large extent on cost of
goods, which are imported. Another factor, which is taken intoconsideration is competitive
pressure brought forth by globalization. The costs of some goods are internationally integrated.
Pressures created for utilizing resources in economies of foreign countries could influence
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domestic inflation.Few economists feel that globalization does not affect the rate of inflation.
This is because the changes, which globalization has brought forth affect relative costs of
services and goods.
On the other hand, there are yet others, who feel inflation is after all the change in the overall
price level. This can be determined by monetary policies. This (monetary policies affecting
inflation) holds true for long term commitments.With regard to short or medium run
commitments, it may not hold true.
Effect of inflation Investment
Inflation, as we know reduces the purchasing power of individuals. Due to inflation, the cost of
goods increases and people have to spend more for buying a particular commodity for, which
they had to pay less early. Inflation inflicts injury to the common man, who lives on limited fixed
income. Even if they have some savings, they are required to use the money to compensate for
inflation. Consequently, they are left with little money to fund for investments. The more an
individual routes the savings for investments, the greater are the chances for boosting growth in
the economy.
Inflation and investment- an overview:
Inflation and investment are required to be more compatible to facilitate growth in the trading
sector of a country, thereby facilitating economic headway. Inflation affects exchange rates,
interest rates among various other economic indicators. As the exchange rates get affected and
start varying, predicting future trends in the value of currencies become difficult. A certain
amount of uncertainty remains and this de motivates the trading partners. The volatility, which is
associated with inflation, affects different production activities in the market. It also enhances the
hazards associated with this volatility.
Inflation and investment compatibility is desirable, not only for matters related to trade but also
for other investment tools like market shares, bonds and stocks. However, if one invests in
stocks, the individual is not required to lose sleep. The reason being, the revenues earned by a
company over a period of time is likely to compensate for the rise in the rate of inflation.When
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inflation occurs, borrowers as well as lenders do not opt for long term commitments.
The worst affected are the retired individuals. To execute retirement schemes, a careful analysis
of the market conditions need to be carried out. Due to inflation, predicting future trends
becomes very difficult. With rise in inflation, costs of goods an increase. To meet the
requirements, one has to depend on the savings and this leads to the erosion of actual savings of
the individual.
Inflation and investment- measures to counteract the ill effects of
inflation:
Treasury Inflation Protected Securities (TIPS) is a bond or a treasury note, which prevents the
returns (on investments) of individuals from being gnawed away by inflation.
Effect of inflation on Stock Market
Inflation is a state in the economy of a country, when there is a price rise of goods as well as
services. To meet the required price rise, individuals have to shell out more than ispresumed.With increase in inflation, every sector of theeconomy is affected.Ranging fromunemployment, interest rates, exchange rates,investment, stockmarkets,there is an aftermath
of inflation in every sector. Inflation is bound to impact all sectors, either directly or indirectly.
Inflation and stock market have a very close association. If there is inflation, stock markets are
the worst affected.
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Inflation and stock market- the logistics:
Prices of stocks are determined by the net earnings of a company. It depends on how much
profit, the company is likely to make in the long run or the near future. If it is reckoned that a
company is likely to do well in the years to come, the stock prices of the company will escalate.
On the other hand, if it is observed from trends that the company may not do well in the long run,
the stock prices will not be high. In other words, the prices of stocks are directly proportional to
the performance of the company. In the event when inflation increases, the company earnings
(worth) will also subside. This will adversely affect the stock prices and eventually the returns.
Effect of inflation on stock market is also evident from the fact that it increases the rates ifinterest. If the inflation rate is high, the interest rate is also high. In the wake of both (inflation
and interest rates) being high, the creditor will have a tendency to compensate for the rise in
interest rates. Therefore, the debtor has to avail of a loan at a higher rate. This plays a significant
role in prohibiting funds from being invested in stock markets.
When the government has enough funds to circulate in the market, the cost of goods, services
usually go up. This leads to the decrease in the purchasing power of individuals. The value of
money also decreases. In a nut shell, for the economy to flourish, inflation and stock market
ought to be more conforming and predictable.
Effect of inflation on manufacturers:-
Manufacturing inflation, with the largest weight of 69.75% in the index's computation, rose to
11.61% in March from 11.16% in February.Publishers recorded the highest inflation among
manufacturers with an annual increase of 35.64%, followed by manufacturers of electrical
machinery and apparatus, whose prices went up by 34.81%.
Consumer-goods manufacturers saw varied rates within the main sub-groups: food and beverage
producers saw 9.04% inflation, compared to 8.8% in February; protein, fruit, vegetables and
cooking oil producers experienced an annual decline of 0.22% in prices; and dairy-product
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manufacturers saw stable inflation of 13.24%.Producer inflation for other food-product
manufacturers was 27.97%, higher than the previous month's figure of 25.63%. Textile
manufacturing also saw annual inflation of 20.22%.
Inflation, on the other hand, can also be quite destructive. For example, a slow in inflation make
importers' products cheaper, whereas domestic manufacturers' product prices remain the same. A
sudden slow in inflation causes lower imported product prices, meaning two things. First,
because of the lower import prices, more people will by imports opposed to domestically
manufactured products. This hurts domestic production, which in turn may result in rising
unemployment (domestic producers fire employees to keep up with shrinking sales revenue)
Robin Johnson, head of the Industrial Engineering practice at Eversheds LLP, gives his take on
the affect of rising input prices.
Inflation in commodity costs could seriously damage what has to date been a strong recovery in
the manufacturing sector. The question now is whether the lean processes put in place during the
recession can help to offset some of the cost, or whether the costs can be passed on to Original
Equipment Manufacturers and then on to consumers.
If the costs cant be passed on in whole, the manufacturers margins and therefore revenue lines
will in turn be affected. This has created a perfect storm. Manufacturers have had to make cut-
backs, and although demand has continued to grow, albeit fragile, the scarceness of
commodities, which was an issue even before the recession, has started to take on an even
greater significance now. As a result the importance of control of commodities in emerging
economies such as Africa will become both a political, economic and trade DOHA concern.
Obtaining long-term secure supply contracts could therefore be the biggest issue facing
manufacturers in the next 12 months. Take or pay contracts may become prevalent, meaning
that you take or, if you dont, you are required to pay anyway. Sole or exclusive or regional
supply chains will be key.
In the longer term I can see this issue extending outside of areas such as steel and energy, and
starting to impact on commodities such as food and water.We could even see the industry
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reverting back to the 1960s, in which local stockpiling became the norm, as todays logistics
costs combined with the impact of climate change requires suppliers to avoid reliance on long
supply chains and dramatically reduce the gap between themselves and their customers.
Effect on Distribution of Wealth
Inflation has its own effects on the aggregate demand, which in turn puts its effects on total
production and income. Following are the several effects of inflation.
1. As demand for money increases, its price, namely the rate of interest, rises. That brings down
the investment.
2. Inflation reduces the total output of the community.
3. As consumers feel insecure during periods of inflation, their desire to save increases. Thus,
propensity to save rises.
4. As the value of money falls, and consequently the real value of wealth in the hands of
consumers, spending made by the consumers fall.
5. As goods fetch higher prices in the domestic market, it discourages export, and to an extent
encourages imports. More imports deplete the foreign exchange reserve of a country.
6. As profit expectation remains high due to high prices, it encourages investment in some way.
Redistribution of income and wealth take place during periods of inflation. Rate of growth of the
economy in also reduced. During inflation people do not want to hold the money, whose value is
falling. So there may be a conversion into other assets, in the form of bonds, securities or gold
and silver.Wages and profits increase relatively more that rent and interest.
People belonging to the fixed income group are the major losers. Their earnings and accumulated
savings diminish or get eroded. Debtors try to pay back their past debts in currencies which are
of very little value. Low-income groups suffer the most during inflation.
Effect of inflation on Employment
Inflation and unemployment are inter-related. A near full-employment situation with stability
of prices is the aim. However measures to control inflation create unemployment, whereas
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measures to reduce unemployment gives rise to inflation. It is like a trap. It is considered that
a full-employment situation is a country's inflation threshold.
The Philips Curve merges the demand-pull and cost-push inflation and eliminates the
distinction between them. It is proclaimed that the society itself chooses the best possible
combination of price-level and employment. The least desired combination between the two
could thus be eliminated by the society. Thus the Phillips Curve shows the trade-off between
level of unemployment and wage-price increase. It is assumed that wage rise percentage is
slightly more than price rise percentage. It shows that greater the unemployment, the lesser is
the price rise, and vice versa. On the other hand, more the wage rise less is the level of
unemployment, and vice versa.Social costs of involuntary unemployment are quite obvious.It cannot be ignored. Inflation can ultimately be considered as a severe form of taxation on
the economy as a whole
Effects of inflation on monetary policy.
Monetary policy is the process by which the monetary authority of a country controls the supply
of money, often targeting a rate of interest for the purpose of promoting economic growth and
stability. The official goals usually include relatively stable prices and low unemployment.
Monetary theory provides insight into how to craft optimal monetary policy. It is referred to as
either being expansionary or contractionarys where an expansionary policy increases the total
supply of money in the economy more rapidly than usual, and contractionarys policy expands the
money supply more slowly than usual or even shrinks it. Expansionary policy is traditionally
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used to try to combat unemployment in a recession by lowering interest rates in the hope that
easy credit will entice businesses into expanding. Contractionarys policy is intended to slow
inflation in hopes of avoiding the resulting distortions and deterioration of asset values.
Monetary policy differs from fiscal policy, which refers to taxation, government spending, and
associated borrowing.
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Chapter: - 06
After completing this chapter you will come know about:-
Monetary Measures
Fiscal measures
Other Non-monetary Measures
There are broadly two ways of controlling inflation in an economy Monetary measures
and fiscal measures.
Monetary measures and
Fiscal measures
Monetary Measures
The most important and commonly used method to control inflation is monetary policy of the Central Bank. Most
central banks use high interest rates as the traditional way to fight or prevent inflation.
Monetary Measures Used To Control Inflation Include:-
(I) Bank Rate Policy(Ii) Cash Reserve Ratio And
(Iii) Open Market Operations.
Bank rate policy is used as the main instrument of monetary control during the period o
inflation. When the central bank raises the bank rate, it is said to have adopted a dear money
policy. The increase in bank rate increases the cost of borrowing which reduces commercial
banks borrowing from the central bank. Consequently, the flow of money from the commercial
banks to the public gets reduced. Therefore, inflation is controlled to the extent it is caused by
the bank credit.
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Cash Reserve Ratio (CRR):- To control inflation, the central bank raises the CRR which
reduces the lending capacity of the commercial banks. Consequently, flow of money from
commercial banks to public decreases. In the process, it halts the rise in prices to the extent it is
caused by banks credits to the public.
Open Market Operations:-Open market operations refer to sale and purchase of government
securities and bonds by the central bank. To control inflation, central bank sells the government
securities to the public through the banks. This results in transfer of a part of bank deposits to
central bank account and reduces credit creation capacity of the commercial banks.
Monetary measures to control inflation:-
Credit control
Issue of new currency
Demonetization of currency
The monetary measures to control inflation generally aims at reducing money incomes. These
are:
(a) Credit Control:- The central bank could adopt a number of methods to control the quantity
and quality of credit to reduce the supply of money. For this purpose, it raises the bank rates,
sells securities in the open market, raises reserve ratio, and adopts a number of selective credit
control measures, such as raising margin requirements and regulating consumer credit.
(b) Demonetization of Currency: -Another monetary measure is to demonetize currency of
higher denominations. Such a measure is usually adopted when there is abundance of black
money in the country.
(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 the old
currency. Such a measure is adopted when there is an excessive issue of notes and there is
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hyperinflation in the economy.
Fiscal Measures
Fiscal measures to control inflation include taxation, government expenditure and public
borrowings. The government can also take some protectionist measures (such as banning the
export of essential items such as pulses, cereals and oils to support the domestic consumption,
encourage imports by lowering duties on import items etc.)
Fiscal Measures includes the following:-
Monetary policy alone cannot control inflation. Therefore, it should be supplemented by fiscal
measures. The principal fiscal measures are discussed below.
(a) Reduction in Unnecessary Expenditure: The government should reduce unnecessary
expenditure on non-development activities in order to curb inflation.
(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 too high as to discourage saving, investment and production.
(c) Increase in Savings: Another measure is to increase savings on the part of the people so
that their disposable income and purchasing power would be reduced. For this the government
should encourage savings by giving various incentives.
(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: In addition, the government should stop repayment of public debt and
postpone it to some future date till inflationary pressures are controlled. Instead, the government
should borrow more to reduce money supply with the public.
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Other (Direct) Measures
Other measures to control inflation generally aims at increasing aggregate supply and reducing
aggregate demand directly. These are :-
(a)To Increase Production.
The following measures should be adopted to increase production:-
The government should encourage the production of essential consumer goods like food,
clothing, kerosene oil, sugar, vegetable oils, etc.
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) RationalWage Policy: Another important measure is to adopt a rational wage policy.
The best course for this is to link increase in wages to increase in productivity. This will have a
dual effect. It will control wage and at the same time increase 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.
(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 stabilize the prices of necessaries and assure
distributive justice.
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Chapter: - 07
After completing this chapter you will come know about:-
Reasons for inflation in India
Inflation Pressure over the Last Few Months
Inflation in India and other Developed Countries
Inflation during 1980's and 1990's Global Inflation A Comparison With India
REASONS FOR INFLATION IN INDIA
There are four main reasons. The immediate reason for the spurt in the prices of specific food
items, like onions today or earlier in the case of sugar and pulses, is hoarding. Trader cartels,
encouraged by an inept Government, are mainly responsible for this. Assured of inaction,
hoarders are creating artificial shortages and fleecing people from time to time.
Secondly, the growing penetration of big corporate in the food economy, international trade in
food items and speculative futures trading in agricultural commodities has weakened the
governments capacity to control food prices. The share of corporate retail in food distribution
has tripled over the past four years. The Government has manipulated trade policies to allow big
traders to make huge profits through export and import of essential food items like wheat, sugar
and onions. On the other hand, the PDS has been weakened considerably through targeting. In
most states, the role of the ration shops, state agencies like the NAFED etc. and consumer
cooperatives in food distribution, has been whittled down. Therefore, the profit margins o
private traders have also increased, reflected in growing gaps between wholesale and retail prices
as well as farm gate and wholesale prices.
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There are medium and long-term reasons too. Our agriculture is in a crisis. We are not producing
enough to meet the needs of a growing population. The peasantry continues to be in distress,
with 2.5 lakh farmers committing suicide over the past 15 years. State intervention in raising
agricultural productivity has been weakened. The Government is more interested in handing over
this role to big agribusinesses and retail giants like Walmart and Monsanto in the name of a
second green revolution. That will further marginalize the small peasants.
Finally, the cuts in subsidies and price hikes of inputs like diesel and fertilizer are also
contributing to food inflation. The deregulation of petrol prices has led to very steep
hikes in the recent weeks.
Inflation Pressure over the Last Few Months
Retail Prices of Some Essential Commodities in Delhi: 2008 to 2011(Rs./kg)
Item
Retail Price
(end-January
2011)
Retail Price
(end-January
2010)
Retail Price
(end-January
2009)
Retail Price
(end-January
2008)
Rice 23 23 22 17
Wheat 15.5 16 13 13
Atta 17 18 14 14
Chana Dal 35 38 35 35
Arhar Dal 69 84 50 42
Moong Dal 68 81 45 36
Masoor Dal 54 62 62 39
Sugar 34 42.5 23 17
Milk (Rs./litre) 25 22 21 20
Groundnut Oil 135 113 109 121
Mustard Oil 79 71 77 69
Vanaspati 77 57 54 67
Tea Loose 149 156 144 107
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Salt Pack (Iodized) 13 12 11 10
Potato 8 9 8 8
Onion 33 23 21 9
Inflation in India and other Developed Countries
Inflation is spreading across the world's largest emerging nations, leaving a noisy rattle in what
have been the engines of global growth in recent years. Central banks in Brazil, Russia, India
and China, the fast-growing so-called BRIC nations now responsible for nearly a fifth of global
economic activity, have all raised interest rates in recent weeks, and are testing more exotic
measures to stanch rising prices, especially for food: India and Russia banned exports of onions
and wheat, respectively, while China has promised price controls on items such as cooking oil.
Brazil said Friday that its 2010 inflation rate had risen to 5.9%, its fastest rate in six years,raising the chances the nation will push its already sky-high interest rates even higher,
potentially hampering growth.
To be sure, Brazil's single-digit inflation rate is a universe away from the hyperinflation it
suffered in the early 1990s. And some analysts say fears of an emerging-market inflation spiral
are overstated, with current inflation rates still below where they were when prices peaked
before the financial crisis in 2008.Still, the inflation trend is creating tricky policy headaches for
officials from Beijing to New Delhi, including fears that rising food prices in these mostly poor
nations may jeopardize social stability.
"Inflation is one of the major risks for this year," says Nicholas Kwan, economist for Standard
Chartered in Hong Kong. The accelerating price gains in the developing world contrast sharply
with low inflation rates in Europe and the U.S. and persistent price declines in Japan. The
divergence is partly a byproduct of the stronger economic recoveries achieved by emerging
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nations compared with sluggish growth in the West.
Such diverging economic fortunes are complicating inflation-fighting efforts in the developing
world, economists say.Leaders in Brazil and other countries complain that the U.S. Federal
Reserve's decision to pump $600 billion into the economy promotes commodity inflation and
asset bubbles by weakening the dollar. U.S. Federal Reserve Chairman Ben Bernanke said
Friday the stimulus measure wasn't adding to inflation
Inflation during 1980's and 1990's
The nation endured a deep recession throughout 1982. Business bankruptcies rose 50 percent
over the previous year. Farmers were especially hard hit, as agricultural exports declined, crop
prices fell, and interest rates rose. But while the medicine of a sharp slowdown was hard toswallow, it did break the destructive cycle in which the economy had been caught. By
1983, inflation had eased, the economy had rebounded, and the United began a sustained period
of economic growth. The annual inflation rate remained under 5 percent throughout most of the
1980s and into the 1990s.
The Political Impact of the Poor Economy in the 1970s
The economic upheaval of the 1970s had important political consequences. The American
people expressed their discontent with federal policies by turning out Carter in 1980 and electing
former Hollywood actor and California governor Ronald as president.
Reagan's Economic Policy
Reagan (1981-1989) based his economic program on the theory of supply-side economics, which
advocated reducing tax rates so people could keep more of what they earned. The theory was that
lower tax rates would induce people to work harder and longer, and that this in turn would lead
to more saving and investment, resulting in more production and stimulating overall economic
growth.While the Reagan-inspired cuts served mainly to benefit wealthier Americans, the
economic theory behind the cuts argued that benefits would extend to lower-income people aswell because higher investment would lead new job opportunities and higher wages.
The Size of the Government
The central theme of Reagan's national agenda, however, was his belief that the federal
government had become too big and intrusive. In the early 1980s, while he was cutting taxes,
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Reagan was also slashing social programs. Reagan also undertook a campaign throughout his
tenure to reduce or eliminate government regulations affecting the consumer, the workplace, and
the environment. At the same time, however, he feared that the United States had neglected its
military in the wake of the VietnamWar, so he successfully pushed for big increases in defense
spending.
The combination of tax cuts and higher military spending overwhelmed more modest reductionsin spending on domestic programs. As a result, the federal budget deficit swelled even beyondthe levels it had reached during the recession of the early 1980s. From $74,000 million in 1980,the federal budget deficit rose to $221,000 million in 1986. It fell back to $150,000 million in1987, but then started growing again. Some economists worried that heavy spending andborrowing by the federal government would re-ignite inflation, but the Federal Reserve remainedvigilant about controlling price increases, moving quickly to raise interest rates any time itseemed a threat. Under chairman Paul Volcker and his successor, Alan Greenspan, the FederalReserve retained the central role of economic traffic cop, eclipsing Congress and the president inguiding the nation's economy.
Global Inflation A Comparison With India
Inflation is no stranger to the Indian economy. In fact, till the early nineties Indians were used to
double-digit inflation and its attendant consequences. But, since the mid-nineties controlling
inflation has become a priority for policy framers.
Inflation today is caused more by global rather than by domestic factors. Naturally, as the Indian
economy undergoes structural changes, the causes of domestic inflation too have undergone
tectonic changes. Needless to emphasise causes of today's inflation are complicated. However, it
is indeed intriguing that the policy response even to this day unfortunately has been fixated on
the traditional anti-inflation instruments of the pre-liberalization era.
Global imbalance the cause for global liquidity
The psychological dimension
Higher international farm prices impact Indian farm prices
Growth and forex flows
Revaluation of the Indian Rupee
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conclusion
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