Inflation: A sustained increase

Inflation: A sustained increase in the general level of prices for goods and services over the time is called inflation. If the price of one good has gone up, it is not inflation; it will be inflation only if the prices of goods have gone up over a period of time.

Types of Inflation

(a) Demand – Pull Inflation: In this type of inflation, prices increase results from an excess of demand over supply for the economy as a whole. Demand inflation occurs when supply cannot expand any more to meet demand; that is, when critical production factors are being fully utilized, also called Demand inflation.

(b) Cost – Push Inflation: This type of inflation occurs, when general price levels rise owing to rising input costs. In general, there are three factors that could contribute to Cost-Push inflation: rising wages increases in corporate taxes, and imported inflation.

Deflation is when the general level of prices falling over period of time, the opposite situation of Inflation. Disinflation on the other hand, refers to a slower rate of inflation.

Stagflation: Stagflation refers to economic condition where economic growth is very slow or stagnant and prices are rising.  The term stagflation was coined by British politician Iain Macleod, who used the phrase in his speech to parliament in 1965.

The side effects of stagflation are increase in unemployment  accompanied by a rise in prices, or inflation. Stagflation occurs when the economy isn’t growing but prices are going up. At international level, this happened during mid-1970s, when world oil prices rose dramatically, fuelling sharp inflation in developed countries.

Hyperinflation: Hyperinflation is a situationwhere the price increases are too sharp. Hyperinflation often occurs when there is alarge increase in the money supply, which isnot supported by growth in Gross Domestic Product (GDP).  Such a situation results in an imbalance in the supply and demand for the money.

Effects of Inflation

There are multi-dimensional effects of inflation on economy at macro and micro levels. Let’s discuss it:

On Export: When inflation in domestic market Exportable items of an economy gains competitive prices in the world economy. Due to this, the volume of export increases and thus export income increases in the economy.When there is inflation, Export gains benefit.On Investment: There is a direct impact of inflation on Investment in the economy. Higher inflation indicates higher demands and suggests entrepreneurs to expand their production level, and, Higher the inflation, lower the cost of loan.On Lending: With the rise in inflation, lending institutions feel the pressure of higher lending. Institutions don’t revise the nominal rate of interest as the real cost of borrowing falls by the same percentage with which inflation rises.On Creditors and Debtors: Inflation redistributes wealth from creditors to debtors i.e. lenders suffers and borrowers benefit out of inflation.On Import: In case of imports, the economy does not get any benefit and loses more foreign currency instead of saving it.On Employment: Inflation increases employment in short run.

Indexes related to Inflation in India

WPI

The Wholesale Price Index (WPI) is an index that measures and tracks the changes in price of goods in the stages before the retail level. It shows the average price changes of goods sold in bulk, and they are a group of the indicators that follow growth in the economy.

The current series of Wholesale Price Index has 2011-12 as the base year, which is last updated in 2015 on the recommendations of the National Statistical Commission's Recommendation.

CPI

The consumer price index (CPI) is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care. The CPI is calculated by taking price changes for each item in the predetermined basket of goods and averaging them.

CPI is also used for indexing dearness allowance to employees for increase in prices. CPI is therefore considered as one of the most important economic indicators.

Urjit Patel Committee report on inflation

The most important recommendations are as follows

RBI must target inflation only- leave unemployment, growth, exchange rate. The target should be CPI 4% +/- 2%RBI fix accountability: At present, monetary policy is made by the governor alone.Government to help RBI fight inflation:RBI’s monetary policy fails to yield result because of government’s policies and subsidies, Loan Waiver.

How can government fight inflation?

According to the Economic Survey, It hints the government can fight inflation through:

1. Cut down Fiscal deficit, as per time-bound targets under the Fiscal Responsibility and Budget Management (FRBM) Act.

2. Deregulate power–sector reforms, and generally the move from administered to market-determined prices. This will raise inflation in short term but in long term, it’ll reduce fiscal deficit and thereby reduce inflation.

3. MNREGA doesn’t improve productivity of the agricultural sector commensurately. Raising MNREGA wages => shortage of farm labour => input cost increased, food supplies decreased -> food inflation.

Therefore, MNREGA should be restructured to create productive assets.

4. Agriculture: MSP should be linked with cost of production. FCI’s Procurement should not be open-ended. Bring UREA under NBS (Nutrient Based Subsidy) scheme. Give Fertilizer Subsidy to farmers instead of companies. Some stages charge ~15% mandi tax, and use that money to pay bonus above MSP to farmer (for vote bank politics). This practice must be stopped.

5. FCI should release grains in market to soften food inflation.

6. Government should reduce restrictions on agriculture exports.

What has Government done to fight Inflation?

Government has taken a number of measures to curb inflation, particularly food inflation. Some of the major steps taken by the Government are:

Higher allocation of rice under Public Distribution System (PDS) and higher allocation of wheat under Open Market Sales Scheme (Domestic) for 2014-15.Moderation in increases in the Minimum Support Prices.Advisory to the states to allow free movement of fruits and vegetables bydelisting them from the Agricultural Produce Market Committee (APMC) Act.Improving availability of essential commodities by facilitating import of various items of mass consumption at zero or concessional import dutiestogether with restriction on export,prescribing stock holding limits under Essential Commodities Act in respect of onion and potato, pulses, edible oil and edible oilseeds and fixing of Minimum Export Price (MEP) for potatoes and onions.

Thanks