Adv. Grace Deebthee John
Contents
Introduction
What is Inflation?
Causes of Inflation
Types of Inflation
Effects of inflation as Indian Economy
Measures to Control Inflation
Conclusion
FAQs
An economy experiences inflation when the average level of prices for goods and services rises steadily and significantly over time. It influences a nation’s overall economic growth and stability as well as the purchasing power of its citizens. Both the general population and authorities have been deeply concerned about India’s long-standing inflation problem. Inflation in India is at 6.66% as of March 2023. Over the course of the last sixty-one years, India’s consumer price inflation rate has fluctuated between -7.6% and 28.6%. India’s inflation rate averaged 6.04% between 2012 and 2023, peaking at 12.17% in November 2013 and falling to a record low of 1.54% in June 2017.
WHAT IS INFLATION?
A prolonged, unregulated rise in the general level of prices and a decline in the purchasing power of money are both considered indicators of inflation. It is a condition of price increase as a result. The inevitable decline in the purchasing power of a given currency is known as inflation. The rate of reduction in purchasing power can be quantified by tracking the average price level of a basket of chosen goods and services over time in an economy. A rise in the general level of prices, usually expressed as a percentage, means that one unit of money now purchases less than it did in the past. Deflation is the opposite of inflation, which occurs when prices decline while the purchasing power of money increases.
CAUSES OF INFLATION
A persistent rise in the average level of prices for goods and services within an economy over time is referred to as inflation. For many years, India has struggled with inflation, which continues to be a significant obstacle for decision-makers. Numerous factors, such as shifts in the money supply, production costs, consumer demand, and external factors like oil prices worldwide, can contribute to inflation. In this regard, comprehending the underlying causes of inflation in India is crucial to creating solutions that effectively address it.
Increasing money supply is the root cause of inflation, which can happen for a variety of reasons in the economy. By printing and distributing more money to people, legally devaluing the legal tender currency, or most frequently lending new money into existence as reserve account credits through the banking system by buying government bonds from banks on the secondary market, the monetary authorities can expand the money supply. Every time the money supply is expanded, the purchasing power of the currency decreases.
TYPES OF INFLATION
There are two types of inflation, as follows:-
Demand Pull Inflation
Cost Push Inflation
Built-In Inflation
Demand Pull Inflation
When demand for products and services in the economy outpaces supply, demand-pull inflation takes place. The supply of goods and services that can be bought may stay the same or decline as demand rises. When there are limitations in supply, demand-pull inflation—which economists define as too many dollars chasing too few goods causes prices to rise. Another factor that can cause this kind of inflation is an increase in aggregate demand. Cost-push inflation is comparable to demand-pull inflation. A common occurrence that happens when customer demand for a variety of consumer products exceeds supply is known as demand-pull inflation.
The entire cost of living rises as demand-pull inflation takes hold. The pull of demand According to Keynesian economics, inflation is the result of an imbalance between total supply and demand. Prices rise in economies where total demand significantly exceeds total supply. Inflation is most frequently caused by this.
Cost Push Inflation
Cost-push inflation, sometimes referred to as wage-push inflation, is the phenomenon whereby rising wages and raw material costs drive up overall prices. Increased manufacturing costs have the potential to reduce an economy’s aggregate supply, or total production. Price rises from manufacturing are passed on to consumers, resulting in cost-push inflation, if demand for the impacted goods has not altered.
The rate of price rises for a selected basket of goods and services within an economy is known as inflation. If salaries haven’t increased sufficiently or kept pace with rising costs, inflation may reduce a consumer’s purchasing power. When a company’s production expenses increase, its senior management may attempt to pass the cost increases on to customers by raising the prices of their goods. If the business doesn’t raise prices, its earnings will decline as production expenses rise.
The primary driver of cost-push inflation is an increase in manufacturing costs, which might be predicted or unanticipated. For instance, rising production costs could result from rising inventory or raw material prices. Cost-push inflation requires that the demand for the impacted product stay the same while the changes in manufacturing costs are taking place. Producers boost consumer prices to offset rising production costs in order to preserve profit margins and meet anticipated demand.
Cost-push inflation is caused by rising labor expenses, such as when production workers are required to earn higher wages because the minimum wage per worker is raised. A strike by employees over unfinished contract discussions may also result in lower output and, consequently, increased costs.
Built-In Inflation
The concept that individuals anticipate that current inflation rates will persist in the future is known as adaptive expectations, and it is linked to built-in inflation. People may anticipate a steady increase in the future at a comparable rate as the cost of products and services continues to climb.
Workers may therefore want higher prices or pay in order to preserve their standard of living. As one element leads to another and vice versa, their greater wages drive up the cost of products and services, perpetuating the wage-price spiral.
Effects of Inflation on Indian Economy
The economy does not bear the full impact of inflation. A variety of goods and services in the economy may have hidden costs. Inflation that occurs suddenly or without warning is bad for the economy as a whole. They cause market volatility, which hinders businesses’ ability to plan their long-term budgets. Productivity can be negatively impacted by inflation since it forces businesses to reallocate resources from goods and services to offset inflation-related profits and losses.
Labor markets are able to achieve equilibrium more quickly when inflation is moderate.
Income and Wealth Redistribution: As a result, income and wealth are transferred from one person to another. Gains for one group of individuals and losses for another are the outcomes.
Consumers’ purchasing power is impacted by high inflation because products and services become more expensive. Particularly for the poor and middle classes, who spend a significant amount of their income on necessities, this may result in a decline in their level of living.
Increased labor and raw material prices brought on by inflation can reduce company profit margins, which may result in reduced investment and employment.
Interest Rates: In order to counteract excessive inflation, the RBI usually boosts interest rates. Reduced borrowing and expenditure due to higher interest rates can impede economic expansion.
Costs associated with borrowing- Higher interest rates raise the cost of borrowing for both individuals and companies, which may discourage investment and spending.
Flexible Income Group vs. Fixed Income Group: The salaries of flexible income groups, such as self-employed people and sellers, are unaffected by inflation. However, as their fixed income’s purchasing power declines, fixed-income groups such as daily wage earners lose out.
Bond Issuers vs. Debenture or Bond Holders: Bond holders lose, while bond issuers profit. This is because inflation cannot be adequately offset by the bonds’ fixed rate.
Equity Holders: The income of equity holders is contingent upon the company’s profitability. When there is inflation, businesses make more money. Thus, equity owners also benefit from higher incomes.
Pay and Employment Wages: In response to the growing cost of living, workers may request raises. Businesses may raise prices to offset increased wage expenses, which would further drive inflation and create a wage-price spiral.
Employment: As businesses deal with increased expenses, inflation may result in fewer jobs in the near future. But if inflation is fueled by robust demand, it may also result in the creation of jobs in some industries.
Measures to Control Inflation
Monetary Policy: The RBI uses instruments like reserve requirements and interest rates to manage inflation. The RBI lowers borrowing costs by raising interest rates, which can curb expenditure and moderate inflation. On the other hand, decreasing interest rates might encourage investment and consumption.
Fiscal Policy: The government can affect the economy by modifying its tax and spending policies. An overheated economy can be cooled and inflation can be controlled by raising taxes or cutting spending.
Improvements to the Supply Chain: By lowering production and transportation expenses, improving the effectiveness of supply networks can aid in the management of inflation. Investing in ports, railroads, and roadways may fall under this category.
Control of Essential Commodities: The government has the authority to control the costs of products and services such as food and gasoline. Making sure these things are priced steadily will help avoid sudden increases in inflation.
Administrative Measures: A rational Wage Policy helps to bring the cost of production and hence prices of goods and services under control. At times, the government may resort to direct price control by fixing maximum price limits through the Administered Price System or Subsidy Programs. The method of rationing (i.e. fixing quota for consumption of a particular good) helps keep the demand under control and hence reduces prices.
CONCLUSION
Along with the country’s expanding population and rising demand for goods and services, the Reserve Bank of India’s (RBI) monetary policy decisions—such as those pertaining to interest rates and the money supply—also have an effect on inflation. Additionally, the inflation rate in India is impacted by global events, such as shifts in the price of commodities internationally.
The effects of high inflation on India’s economy are extensive, impeding growth by raising uncertainty and decreasing purchasing power. Income disparity is further exacerbated by inflation, which disproportionately impacts the weak and impoverished. Due to the fact that high inflation can devalue money, businesses and investments are also affected. The government can modify taxes and spending to affect aggregate demand and inflation, while the RBI employs monetary policy instruments to limit inflation.
FAQS
1. What is inflation?
Inflation is the sustained rise in the general price level of goods and services over time, leading to a decrease in the purchasing power of money. It is usually expressed as a percentage increase in prices.
2. How does inflation affect the purchasing power of money?
As prices rise during inflation, the value of money decreases. This means that the same amount of money buys fewer goods and services than before.
3. What are the main types of inflation?
There are three primary types of inflation:
1.Demand-Pull Inflation:Occurs when demand for goods and services exceeds supply.
2. Cost-Push Inflation: Happens when rising production costs (e.g., wages, raw materials) lead to higher prices.
3. Built-In Inflation: Results from expectations of continued inflation, causing wages and prices to rise in a self-perpetuating cycle.
4.How does inflation impact the Indian economy?
Inflation affects the Indian economy in several ways:
1.Reduced Purchasing Power:Especially for the poor and middle class.
2. Income Redistribution: Fixed-income groups suffer more than flexible-income earners.
3. Higher Costs:Increased costs for businesses reduce profit margins and investment.
4. Interest Rates:The Reserve Bank of India (RBI) raises rates to control inflation, which impacts borrowing.
5. What is demand-pull inflation?
Demand-pull inflation occurs when consumer demand for goods and services outpaces supply, leading to rising prices. It is often described as “too much money chasing too few goods.”
6.What is cost-push inflation?
Cost-push inflation happens when rising production costs, such as wages or raw materials, force businesses to increase prices to maintain profit margins.