EDEN IAS

Inflation

WHAT IS INFLATION?

Introduction to Inflation

Inflation means a persistent rise in the average price of goods and services. If price rise moderately, it is a positive development as it shows there is a growth in the economy. But if prices rise steeply, it hurts almost the entire economy without any benefits-growth; budgetary balance; welfare; reduces the purchasing power of money; impoverishes the poor disproportionately more as a greater proportion of their incomes are needed to pay for their consumption; reduces savings; pushes up interest rates; dampens investment. In other words, the entire macroeconomic stability rests on inflation if it reaches unsustainable levels. Therefore, the government policies aim at growth with price stability- which is moderate inflation on a long-term basis.

Depending upon the rate of growth of prices, inflation can be of the following types:

  • Creeping inflation- it is a general price increase of up-to 4% a year. It is largely positive from a systematic perspective as it shows there is growth and so is referred to as price stability. It is considered good for economy as producers and traders make reasonable profits encouraging them to invest.
  • Trotting inflation- is when creeping inflation increases. If not controlled, trotting inflation may accelerate into a galloping inflation which may be around 8-10% a year. If it aggravates, galloping inflation can aggravate to “runaway” inflation which may change into hyperinflation.
  • Hyperinflation- it defines a situation when prices are “out of control”. That is monthly inflation rate of 20 or 30% are more- ‘an inflationary cycle without any tendency towards equilibrium’. It is the result of reckless fiscal policy that creates excess money through deficit financing. It may also be caused due to war when fiscal resources and civilian production bases are diverted for military purposes.

Other related concepts to inflation are-

  • Deflation- When the prices grow at a rate that is less than zero. That is if an item that was sold for Rs. 10 is being sold for less than Rs. 10 on a persistent basis, it is called deflation. If such drop-in prices take place in general, it is called deflation. Deflation increases the value of money which allows one to buy more goods and services than before with same amount of currency.
  • Disinflation- It is the reduction of rate of inflation. It is the rate of growth of prices that is slowing but prices are increasing. If the inflation rate is not very high, disinflation can result in deflation. It is the opposite of reflation which is return of inflation. Government policy should aim at disinflation if the prices are high but not otherwise.
  • Stagflation- It is combination of inflation and rising unemployment due to recession. It comes from two words- stagnation and inflation. It is macroeconomic condition when the inflation rate is high, the economic growth rate slows or economy goes into de-growth (recession) and unemployment rises.
  • Reflation- Which is when inflation returns after a spell of deflation and recession thus showing that growth is back: US and EU after the great recession (2007-09) when growth was revived.
  • Open inflation- One of the primary responsibilities of the government is to ensure affordability of goods and services. Thus, government subsidize goods and services to keep them inexpensive. For example, kerosene, food, transport The inflation that results when the government does not suppress it with subsidies and monetary policy is called open inflation.
  • Suppressed inflation- Inflation is too big for the economy for the government to allow it to continue unchecked. Therefore, fiscal and monetary actions are taken to manage it at a moderate level. That is called suppressed inflation.
  • Headline inflation- It is the raw inflation reported through consumer price index (CPI) that is released monthly by bureau of labour statistics. It is not adjusted to remove high volatile figures, including those that can shift regardless of economic conditions.
  • Core inflation- It measures the long-run trend in the general price level. Temporary effects on inflation are factored out to calculate base inflation. For this purpose, certain items are excluded from the computation of core inflation. These items include: change in price of fuel and food and the processed food part of manufacturing. The reason is that they are volatile, being subject to short-term fluctuations and are seasonal in nature like food items.

WHAT ARE THE DIFFERENT WAYS TO MEASURE INFLATION IN INDIA?

Inflation

The two primary indices used to measure inflation in India are Consumer Price Index (CPI) and Wholesale Price Index (WPI).

Inflation

According to the products’ specified weights, the goods and commodities part of WPI is divided into the following categories:

  1. Manufactured goods (64.23%)
  • Textile and textile products
  • Paper and paper products
  • Machinery
  • Tobacco and tobacco products
  • Beverages
  • Wood and wood products
  • Rubber and rubber products
  1. Primary articles (22.62%)
  • Food articles
  • Non-food articles
  • Minerals
  1. Food and fuel (13.15%)
  • Power
  • Lubricants
  • Electricity
  • Coal mining

CAUSES OF INFLATION

inflation

 GOVERNMENT STEPS TO CONTROL INFLATION

The government has taken a number of short term and medium-term measures to improve domestic availability of essential commodities and moderate inflation. Some of them are as follows-

  • Monetary policy- central bank uses this policy in order to counter inflation. Such as the pertaining tools like interest rates, reserve requirements, and open market operations to control inflation. By increasing interest rates or reserve requirements, the central bank can reduce the amount of money in circulation, which can help to control inflation.
  • Fiscal policy- governments uses fiscal policy tools such as taxation and government spending to control inflation. By increasing taxes or reducing government spending, the government can reduce the amount of money in circulation, which can help to control inflation.
  • Supply-side measures- It also act as one of the methods in order to counter inflation such as increasing the production of goods and services, promoting competition and improving productivity. By increasing the demand of goods and services government can decrease the demand in the economy which further help to counter inflation.
  • Wage and price controls– governments can also implement wage and price controls to counter inflation. Wage controls can limit the amount by which wage increase, which can help to reduce the cost of production. Price controls can limit the amount by which prices can increase, which can help to counter inflation.

However, it’s important to note that controlling inflation is a delicate balance. While inflation is undesirable, too much control can lead to a slowdown in economic growth. Therefore, policymakers must carefully balance the need to control inflation with the need to maintain economic growth.

Sources- NCERT, PIB