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1. INFLATION

3. Inflation- meaning and measurement, Causes of
inflation, Effects of inflation,
• Inflation- meaning and measurement, Causes of inflation, Effects of
inflation,
• “Inflation poses a serious threat to the growth momentum. Whatever
be the cause, the fact remains that inflation is something which needs
to be tackled with great urgency …”
• Inflation and unemployment are the two most talked-about
words in the contemporary society.

4. • when compared with inflation figures of other countries. Data available with Trading
Economics showed that Zimbabwe’s inflation stood on the top at 285 per cent in August
2022. It was followed by Lebanon (168 per cent), Syria (139 per cent), Sudan (125 per
cent) and Venezuela (114 per cent). Overall, the data further indicated that more than 100
countries have inflation higher than India.
• Among the major economies in Asia, inflation in Sri Lanka stood at 64.30 per cent in
August. Iran, Pakistan, Myanmar and Kazakhstan had inflation of 52.20 per cent, 27.26 per
cent, 17.78 per cent and 16.1 per cent, respectively.
• In the Americas, Colombia’s inflation was hovering around 10.84 per cent last month.
Other major countries including Paraguay, Jamaica, Brazil and the United States hit
inflation of 10.50 per cent, 10.2 per cent, 8.73 per cent and 8.3 per cent, respectively in
August.

5. • Saugata Bhattacharya, VP and Chief Economist, Axis Bank said, “Inflation
remains a problem. I don’t think just a monetary policy response that is going
to moderate this. It has to be coordinated with fiscal, trade and industry policy,
even a diplomatic initiative using oil to tame inflation. Fortunately, in India,
inflation is nowhere close to being the problem like the developed markets.

7. • The annual inflation rate in India increased to a five-month high of
7.41% in September of 2022 from 7% in August, above market
forecasts of 7.3%. Prices increased faster for food (8.6% vs 7.62% in
August), with vegetables (18.05%), spices (16.88%), cereals and
products (11.53%) recording the biggest rises as erratic rainfall
impacted the local crops and supply shock from the Russian
invasion of Ukraine remained. Prices of housing (4.57% vs 4.06%);
education (5.68% vs 5.51%); transportation & communication
(5.39% vs 5.2%); and health (5.52% vs 5.43%) also accelerated. On
the other hand, the cost of fuel and light grew at a slightly slower
pace (10.39% vs 10.78%). Compared to the previous month,
consumer prices were up 0.57%

8. • In India, the most important category in the consumer price index is Food
and beverages (45.86 percent of total weight), of which Cereals and
products (9.67 percent), Milk and products (6.61 percent), Vegetables
(6.04 percent), Prepared meals, snacks, sweets, etc. (5.55 percent), Meat
and fish (3.61 percent), and Oils and fats (3.56 percent). Miscellaneous
accounts for 28.32 percent, of which Transport and communication (8.59
percent), health (5.89 percent), and education (4.46 percent). Housing
accounts for 10.07 percent; Fuel and light for 6.84 percent; Clothing and
footwear for 6.53 percent; and Pan, tobacco and intoxicants for 2.38
percent. Consumer price changes in India can be very volatile due to
dependence on energy imports, the uncertain impact of monsoon rains on
its large farm sector, difficulties transporting food items to market because
of its poor roads and infrastructure and high fiscal deficit. In 2013, the
consumer price index replaced the wholesale price index (WPI) as a main
measure of inflation.

9. Inflation explained with an example
• Suppose for Rs.100, last week you bought 5 Kg. of rice. This means
that the cost of 1Kg of rice was Rs. 20. This week when you
approached the same shop-keeper and paid Rs.100 to get rice, he
gave only 4 Kg of rice. He also explained that the price of rice has
increased, and now it is Rs.25 per Kg.
• This example clearly explains the fall in the purchasing power of
money. For Rs. 100 you could get 5 Kg rice before, but now only 4
Kg. So purchasing power of money got reduced. This is inflation.
And let’s us calculate the inflation rate (percentage). If price of rice,
which was Rs.20 per Kg increased to Rs.25, this corresponds to
Rs.5 increase on Rs.20, ie. 25% increase. So the inflation rate is
25%, which is obviously a very high rate.

13. • 1] Creeping Inflation
• Creeping inflation also known as mild inflation is as the name
suggests a very slow rise in prices of goods and services. If the
prices increase by 3% or less annually, then such inflation is
creeping inflation. Such inflation is not harmful to the economy. In
fact, as per the Federal Reserve, a 2% inflation rate is desirable. It is
necessary for the economic growth of a country.
• 2] Walking Inflation
• In this case, the inflation rate falls between 3% to 10%. Such inflation
can be harmful to the economy. The economic growth of the country
is too accelerated to sustain. Consumers start stocking goods
fearing the prices will rise further. This causes excess demand and
the prices increase further.

14. • 3] Galloping Inflation
• When creeping and walking inflation are left unchecked, the rate of
inflation will rise above 10%. This is galloping inflation. The currency of the
country will lose value in the global economy. The salaries and income of
common people will not be able to keep up with the ever-increasing prices
of commodities. This will lead to the general instability of the economy and
the country as a whole.
• 4] Hyperinflation
• Next in the classification of inflation is hyperinflation. This when the
inflation is completely out of control. No measures taken by the monetary
authorities can control the prices. The rate of inflation can be 50% on a
monthly basis. This is the last stage of inflation. A real-world example is
that of Venezuela, where the IMF has predicted prices rose 13,000% in
2018.

15. How to measure Inflation rate?
• Inflation can be measured at three levels – producer, wholesaler
and retailer (consumer).
• Prices generally rise in each level till the commodity finally
reach the hand of consumer.
• Inflation at Producer Level
• As of now in India, there is no index to measure inflation at
producer level. A Producer Price Index (PPI) is proposed, but so
far this type of inflation calculation has not started in India.

16. Inflation at Wholesale Level
• This is the most popular inflation rate calculation methodology in
India. The index used to calculated wholesale inflation is known as
Wholesale Price Index (WPI). WPI is released by the Ministry of
Commerce and Industry.
• Though RBI used WPI for most of its policy decisions before 2014.
WPI shows the combined price of a commodity basket comprising
676 items.
• But WPI does not include services, and it neither reflect the
bottlenecks between producer and wholesaler nor between
wholesaler and retailer (consumer).
• Hence from 2014, as part of the reforms initiated by RBI governor
Raghu Ram Rajan, RBI shifted to CPI for policy decisions.

17. Inflation at Retail Level (Consumer Level)
• Inflation at Retail Level (Consumer Level)
• Consumer often directly buys from retailer. So the inflation
experienced at retail shops is the actual reflection of the price
rise in the country. It also shows the cost of living better.
• In India, the index which shows the inflation rate at retail level is
known as Consumer Price Index (CPI).
• CPI is based on 260 commodities, but includes certain services
too.

18. • There were four Consumer Price Indices covering different
socio-economic groups in the economy.
• These four indices were Consumer Price Index for Industrial
Workers (CPI-IW);
• Consumer Price Index for Agricultural Labourers (CPI-AL);
Consumer Price Index for Rural Labourers (CPI -RL) and
Consumer Price Index for Urban Non-Manual Employees (CPI-
UNME).

19. • CPI is now using a new series on the base 2010=100 for all-
India and States/UTs separately for rural, urban and combined.
• The Central Statistics Office (CSO), Ministry of Statistics
and Program Implementation releases Consumer Price Indices
(CPI).
• CPI is based on retail prices and this index is used to calculate
the Dearness Allowance (DA) for government employees.

22. • 1. A depreciation of the exchange rate which makes exports more competitive in
overseas markets leading to an injection of fresh demand into the circular flow and a rise
in national and demand for factor resources – there may also be a positive multiplier
effect on the level of demand and output arising from the initial boost to export sales.
• 2. Higher demand from a government (fiscal) stimulus e.g. via a reduction in direct or
indirect taxation or higher government spending and borrowing. If direct taxes are
reduced, consumers will have more disposable income causing demand to rise. Higher
government spending and increased borrowing feeds through directly into extra demand
in the circular flow.
• 3. Monetary stimulus to the economy: A fall in interest rates may stimulate too much
demand – for example in raising demand for loans or in causing rise in house price
inflation.
• 4. Faster economic growth in other countries – providing a boost to UK exports overseas.
5. Improved business confidence which prompts firms to raise prices and achieve better
profit margins

24. • 1. Component costs: e.g. an increase in the prices of raw materials and components. This
might be because of a rise in global commodity prices such as oil, gas copper and
agricultural products used in food processing – a good recent example is the surge in the
world price of wheat.
• 2. Rising labour costs - caused by wage increases that exceed improvements in
productivity. Wage and salary costs often rise when unemployment is low (creating
labour shortages) and when people expect inflation so they bid for higher pay in order to
protect their real incomes.
• 3. Higher indirect taxes imposed by the government – for example a rise in the duty on
alcohol, cigarettes and petrol/diesel or a rise in the standard rate of Value Added Tax.
Depending on the price elasticity of demand and supply, suppliers may pass on the
burden of the tax onto consumers.
• 4. A fall in the exchange rate – this can cause cost push inflation because it normally
leads to an increase in the prices of imported products. For example during 2007-08 the
pound fell heavily against the Euro leading to a jump in the prices of imported materials
from Euro Zone countries.

25. Effects of Inflations
• (a) Debtors and Creditors
• During inflation, borrowers tend to gain. Hence, lenders tend to
lose.
• Borrowers gain because they repay less in real terms as
compared to when they had borrowed the money
• Lenders lose because when they receive repayment of
their debts, the real value of their money declines by the
amount of increase in the price levels
• In other terms, a borrower receives ‘dear rupees’ but pays back
‘cheap rupees’.

26. • (b) Producers and workers:
• Producers gain because they get higher prices and thus more
profits from the sale of their products. As the rise in prices is
usually higher than the increase in costs, producers can earn
more during inflation. But, workers lose as they find a fall in
their real wages as their money wages do not usually rise
proportionately with the increase in prices. They, as a class,
however, gain because they get more employment during
inflation.

27. • (c) Fixed income-earners:
• Fixed income-earners like the salaried people, rent-earners, landlords,
pensioners, etc., suffer greatly because inflation reduces the value of their
earnings.
• (d) Investors:
• The investors in equity shares gain as they get dividends at higher rates
because of larger corporate profits and as they find the value of their
shareholdings appreciated. But the bondholders lose as they get a fixed
interest the real value of which has already fall
• (e) Traders, speculators, businesspeople and black-marketers:
• They gain because they make more profits from the persistent rise in
prices.

28. • (f) Farmers:
• Farmers also gain because the rise in the prices of agricultural
products is usually higher than the increase in the prices of
other goods.
• Thus, inflation brings a shift in the pattern of distribution of
income and wealth in the country, usually making the rich
richer and the poor poorer. Thus during inflation there is more
and more inequality in the distribution of income.

29. 2. Effects on Production:
• The rising prices stimulate the production of all goods—both of
consumption and of capital goods. As producers get more and
more profit, they try to produce more and more by utilising all
the available resources at their disposal.
• But such favourable effects of inflation upon production are not
always found. Sometimes, production may come to a standstill
position despite rising prices, as was found in recent years in
developing countries like India, Thailand and Bangladesh. This
situation is described as stagflation.

30. • 3. Effects on Income and Employment:
• Inflation tends to increase the aggregate money income (i.e.,
national income) of the community as a whole on account of
larger spending and greater production. Similarly, the volume of
employment increases under the impact of increased
production. But the real income of the people fails to increase
proportionately due to a fall in the purchasing power of money.

31. • 5. Effects on the Government Finance:
• During inflation, the government revenue increases as it gets
more revenue from income tax, sales tax, excise duties, etc.
Similarly, public expenditure increases as the government is
required to spend more and more for administrative and other
purposes. But the rising prices reduce the real burden of public
debt because a fix sum has to be paid in instalment per period.
• 4. Effects on Business and Trade:

32. • 6. Effects on Growth:
• A mild inflation promotes economic growth, but a runaway
inflation obstructs economic growth as it raises cost of develop-
ment projects. Although a mild dose of inflation is inevitable
and desirable in a developing economy, a high rate of inflation
tends to lower the growth rate by slowing down the rate of
capital formation and creating uncertainty.

33. • Conclusion:
• But inflation, especially a runaway inflation, is an unstable
situation. It makes the business world uneasy and uncertain.
Society gets disturbed as there grows discontentment among the
salaried people and they demand an increase in their wages and
salaries.
• The middle-class people suffer hard as the real value of their
income becomes very low. Inflation is also unjust as it makes
one class of people richer and the other poorer. But the most
serious effect of inflation from the standpoint of the economy is
that it makes the economic environment of business unstable.