Inflation - Meaning Types, Causes and Effects of Inflation NEP - KUD .pptx

Inflation- Meaning, causes, types, Effects and Remedial Measures

1. Inflatio n Prof. Nithin Kumar S Assistant Professor Department of Economics J.S.S Banashankari Arts, Commerce and Shantikumar Gubbi Science College Vidyagiri, Dharwad - 580004

2. Introduction Inflation is defined as a sustained increase in the price level or a fall in the value of money. When the level of currency of a country exceeds the level of production, inflation occurs. V a l ue of m on e y de p reci a t es w ith t h e oc c urr e n c e of inflation . Prof. Nithin Kumar S 2

3. Definitions Crowther – “Inflation as a stage in which the value of money is falling, that is, prices are rising” Coulbourn – “Inflation is too much money chasing too few goods ” Prof. Nithin Kumar S 3

4. Johnson – “Sustained or Persistent rise in prices”. R.G.Hawtrey – “Inflation is the issue of too much currency” Prof. Nithin Kumar S 4

5. Gardner Ackley – “Inflation is a persistent and appreciable rise in the general level or average prices” J.M Keynes – “Inflation is the result of the excess of aggregate demand over the available aggregate supply and true inflation starts only after full employment” Prof. Nithin Kumar S 5

6. Types Of Inflation Creeping Inflation Walking Inflation Running Inflation Hyper Inflation Core Inflation Headline Inflation Demand pull Inflation Cost Push Inflation Mild or Healthy inflation Built – in Inflation Stagflation Prof. Nithin Kumar S 6

7. 1. Creeping Inflation It refers to a situation where there is a very mild rise in prices. The level is about 1 – 3 % per annum . This kind of inflation is generally considered to be beneficial to the economy as it favours trade, industry, investment and growth . Prof. Nithin Kumar S 7

8. 2. Walking Inflation It is a situation where the rate of price rise is faster than that in creeping inflation. The sustained rise in price is about 3 – 6 % per annum. Prof. Nithin Kumar S 8

9. 3. Running Inflation It is a situation where the price level rises very fast. In this case price level doubles upon every 3 years, the sustained rise in prices is about 10 %. Prof. Nithin Kumar S 9

10. 4. Galloping Inflation It refers to a situation where the price level rises very rapidly. Generally , in this case, the price level doubles up every 10 months some times every week . Prof. Nithin Kumar S 10

11. 5. Hyper Inflation Hyperinflation is a term to describe rapid, excessive, and out-of-control general price increases in an economy. While inflation measures the pace of rising prices for goods and services, hyperinflation is rapidly rising inflation, typically measuring more than 50% per month . Prof. Nithin Kumar S 11

12. 6. Core Inflation Core inflation refers to inflation based on the consumer price index (CPI), covering the inflation of all the goods and services except the volatile food & fuel prices, excise duties, income tax, and other financial investments. It guides the governments in forecasting long-term inflation trends for a country . Prof. Nithin Kumar S 12

13. 7. Headline Inflation Headline inflation is the total inflation in an economy. The headline inflation figure includes inflation in a basket of goods that includes commodities like food and energy. It is different from core inflation, which excludes food and energy prices while calculating inflation . Prof. Nithin Kumar S 13

14. 8. Demand Pull Inflation Inflation arising out of too much demand for goods as against supply at the full employment level is called demand pull inflation. It is caused by excessive money in the hands of the people and excessive demand . Prof. Nithin Kumar S 14

15. 9. Cost Push Inflation When a rise in the cost of production caused by the demand of labourers for higher wage leads to a rise in prices in goods in spite of the fact that there is no excess demand for goods at the original prices. This inflation occurs due to increase in costs . Prof. Nithin Kumar S 15

16. 10. Mild or Healthy 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. Prof. Nithin Kumar S 16

17. 11. Built – in Inflation Built-in inflation (which is sometimes referred to as a wage-price spiral) occurs when workers demand higher wages to keep up with rising living costs. This in turn causes businesses to raise their prices in order to offset their rising wage costs, leading to a self-reinforcing loop of wage and price increases . Prof. Nithin Kumar S 17

18. 12. Stagflation Stagflation is an economic cycle characterized by slow growth and a high unemployment rate accompanied by inflation. Prof. Nithin Kumar S 18

19. Causes of Inflation Wars Natural Calamities Increase in supply of money Deficit financing Devaluation of currency Dishoarding of money Increase in Wage Costs Bottlenecks in production Higher taxes Excessive Government Expenditure Hoarding and speculation Price rise in other countries Prof. Nithin Kumar S 19

20. 1. Wars During the war resources are diverted to meet the military needs. Consequently the supply of consumption goods decreases, Scarcity of goods and price rise will lead to inflation. Prof. Nithin Kumar S 20

21. 2. Natural Calamities Natural calamities like floods, drought, earthquakes etc. Will adversely affect the normal productive activities and cause the scarcity of goods . This will give rise to an increase in the price level . Prof. Nithin Kumar S 21

22. 3. Increase in supply of money Expansion of the supply of money beyond the normal requirement of trade and Industry is one of the causes responsible for Inflation. Sometimes, The monetary authority adopts a cheap money policy. During the period of cheap money policy, commercial banks lend loan at lower rate of interest and this stimulates borrowings which lead to Inflation . Prof. Nithin Kumar S 22

23. 4. Deficit financing Deficit financing by the government is one of the causes of Inflation. In the course of deficit financing, additional amount of money will be brought in to circulation. It results in increase in the supply of money and forces the prices to go up . Prof. Nithin Kumar S 23

24. 5. Devaluation of currency When the currency of a country is devaluated exports are encouraged and imports are discouraged. As a result, the supply of goods within the country is reduced. The reduced supply of goods within the country forces the prices to go up . Prof. Nithin Kumar S 24

25. 6. Dishoarding of Money When there is a dishoarding of money by the public that is when the hoarded money is brought into circulation by the people. There will be increase in the supply of money. The increase in the supply of money will increase the demand for goods and there by raises prices of goods . Prof. Nithin Kumar S 25

26. 7. Increase in Wage Costs If the labour forces demands higher remuneration without corresponding increase in productivity, the cost of production increases. This will increase the price level. Raise in prices again increases the cost of living. Increased cost of living forces the labourers to demand more wages. The future rise in wages increases the cost of goods and rises the prices of the future . Prof. Nithin Kumar S 26

27. 8. Bottlenecks in production Sometimes production may suffer on account of non-availability of raw materials, shortage of power, strikes and lockouts. This will cause damage to the production process and leads to shortage of goods. This ultimately results in inflation . Prof. Nithin Kumar S 27

28. 9. Higher taxes Sometimes, Fiscal Policy adopted by the Government leads to inflationary pressure in an economy. For example, excise duties levied by the Government will result in rise in prices . Prof. Nithin Kumar S 28

29. 10. Excessive Government Expenditure In the course of rapid economic development and maximum economic welfare the Government of a country, may take a huge investment on a number of projects, which will take a long time to yield results. There will be rise in the income of the people without corresponding increase in the supply of goods. This will push up the price level and leads to inflation. Prof. Nithin Kumar S 29

30. 11. Hoarding and speculation Hoarding of goods by producers and traders to manipulation of profits will create artificial scarcity of goods. This will cause the prices of goods to go up . Prof. Nithin Kumar S 30

31. 12. Price rise in other countries When prices rise in other countries more goods may be exported to other countries to get higher prices. More exports to other countries will result in reduced supply within the Country. The reduced supply within the country causes the price to rise Prof. Nithin Kumar S 31

32. Effects of Inflation Effects on Producers Effects on Consumption Effects on Debtors and Creditors Effects on Investors Effects on Wage Earners Effects on Savings Effects on the Balance of Payments Prof. Nithin Kumar S 32

33. 1. Effects on Producers The producers benefit from inflation as the get as they get higher prices for their finished goods. Producers have to pay higher prices for the various factors of production. But the rise in the prices of factors of production is generally less than the rise in the price of finished goods . Prof. Nithin Kumar S 33

34. 2. Effects on Consumption During inflation the purchasing power of money declines hence rising prices reduce the real consumption of the common people. Consumers are able to purchase a lower quantity of goods and services due to higher cost of living. Prof. Nithin Kumar S 34

35. 3. Effects on Debtors and Creditors Inflation benefits the debtors in the sense that, when there is inflation, the debtors are actually paying back to the creditors less than what they have borrowed. The creditors lose during inflation as they get back from the debtors less than what they have lent Prof. Nithin Kumar S 35

36. 4. Effects on Investors Investors on the shares of companies gain from inflation, as they get higher rate of dividend. Companies earn more profits during inflation Prof. Nithin Kumar S 36

37. 5 . Effects on Wage Earners Inflation is both disadvantageous and advantageous to the wage earners. It is disadvantageous to wage earner as the rise in their wages less than the rise in prices or cost of living. It is advantageous to them in the sense that, during the period of inflation, generally there will be rise in employment. Prof. Nithin Kumar S 37

38. 6. Effects on Savings During Inflation the cost of living rises which increases money expenditure of the household. The capacity or ability to save is largely reduced. This in turn adversely affects the process of capital formation, essential for productive activities. Prof. Nithin Kumar S 38

39. 7. Effects on the Balance of Payments During the period of inflation, a country find it difficult to export goods on account of higher prices of goods. As the domestic supply of goods is not sufficient, it is forced to even import goods. Consequently, its balance of payments becomes adverse. Prof. Nithin Kumar S 39

40. Measures To Control Inflation Monetary Measures Fiscal Measures Other Measures Prof. Nithin Kumar S 40

41. A. Monetary Measures Rise in Bank Rate Open Market Operations Variable Reserve Ratios Varying Margin Requirement Regulation of Consumer Credit Rationing of Credit Prof. Nithin Kumar S 41

42. B. Fiscal Measures Increased taxation Increased borrowing by the government from the public Reduced Expenditure by the government Prof. Nithin Kumar S 42

43. C. Other Measures Wage policy Price control and rationing Savings Scheme Selection of Proper Projects Imports Higher output Private sector investment to be controlled Prof. Nithin Kumar S 43

44. Monetary Measures Monetary measure refers to measures implemented by the Central bank of the country. The Central bank will have to follow a tight money policy and adopt the following measures Prof. Nithin Kumar S 44

45. 1. Rise in Bank Rates Bank rate is the minimum at which the central bank of a country provides financial accommodation to commercial banks. This is also known as discount rate.  The central bank raises the bank rate and thus follows dear money policy. As a result borrowing becomes costly and therefore borrowing from commercial bank is discouraged. The volume of money in circulation would be reduced . Prof. Nithin Kumar S 45

46. 2. Open Market Operations Open market operations involve the purchase and sale of government securities by the central bank. When the central bank wants to control inflation it sells government securities to the commercial banks. This will control the total volume of credit as the lending capacity of the commercial banks is reduced. Thus volume of money in circulation can be reduced by open market operations . Prof. Nithin Kumar S 46

47. 3. Variable Reserve Ratios All commercial banks have to keep in deposit with the central bank, a certain percentage of their demand and time deposits, it is called the reserve ratio. When the minimum reserve ratio is raised the reserves of all banks fall. As a result, the value of credit created by the banks will decline. Thus the central bank can influence the value of credit by raising reserve requirements during the inflationary period . Prof. Nithin Kumar S 47

48. 4. Varying Margin Requirements The commercial banks keep a certain margin while lending money against securities. The margin is the difference between the value of securities offered and loan sanctioned. The central bank can vary margin requirements for controlling credit to brokers and speculators in the stock exchanges and commodity markets. This method also enables the commercial banks to direct their funds to essential activities rather than speculative activities . Prof. Nithin Kumar S 48

49. 5. Regulation of Consumer Credit In order to control the inflationary pressure in the economy the central bank can regulate the consumer credit given to purchase specified durable consumer goods. During the inflationary period the central bank limits the amount of consumer credit extended by commercial banks Prof. Nithin Kumar S 49

50. 6. Rationing of Credit It refers to laying down definite credit quotas for each type of business loan. The credit is rationed by fixing a ceiling on the maximum amount of accommodation that a commercial bank can get from the central bank. It may also fix ceiling for specific categories of loans and advances . Prof. Nithin Kumar S 50

51. Fiscal Measures These are the measures undertaken by the Government with regard to taxation, expenditure and public borrowings. During inflation the Government can adopt the following fiscal measures Prof. Nithin Kumar S 51

52. 1. Increased Taxation Taxes determine the size of disposable income in the hands if the public. The Government may increase the taxes or levy new taxes to reduce disposable income of the people . Prof. Nithin Kumar S 52

53. 2. Increased borrowing by the government from the public During the time of inflation Government has to encourage public borrowing in the form of issue of bonds, securities, debentures etc. This will reduce the supply of money in the hands of the public, and combat inflation . Prof. Nithin Kumar S 53

54. 3. Reduced Expenditure by the government To minimize inflationary pressure in an economy in underdeveloped countries, unplanned Government expenditure should be kept under control. Prof. Nithin Kumar S 54

55. Other Measures In addition to monetary and fiscal measures, there are certain other measures to control inflation Prof. Nithin Kumar S 55

56. 1. Wage Policy In order to control cost push inflation, wages should be kept under control. The wage rate can be increased only when productivity of labour increases Prof. Nithin Kumar S 56

57. 2. Price Control and Rationing The prices of essential consumer goods must be prevented from rising through price control and rationing. Rationing refers to controlled distribution of goods. This is generally under taken to strengthen price control Prof. Nithin Kumar S 57

58. 3. Savings Scheme Voluntary and compulsory saving schemes initiated by the Government may absorb excess money with the public and reduce the effective demand for goods and lower the prices . Prof. Nithin Kumar S 58

59. 4. Selection of Proper Projects The pattern of investment should be such that a larger fund flows to those projects which are quick yielding, so that output increases with a short time lag . Prof. Nithin Kumar S 59

60. 5. Imports Larger imports of goods may improve the supply position within the country and thereby contribute to reduction in prices. However, such step is possible only if the balance of payments position permits . Prof. Nithin Kumar S 60

61. 6. Higher Output Higher output in the public as well as in the private sector will increase the supply of goods and contribute to fall in prices . Prof. Nithin Kumar S 61

62. 7.Private Sector Investment to be Controlled To control inflation in an effective manner the investment patterns in the private sector should be controlled. Funds should be prevented from flowing into unproductive and undesirable channels of investment . Prof. Nithin Kumar S 62

63. Wholesale Price Index & Consumer Price Index

64. Wholesale Price Index (WPI ) Wholesale Price Index (WPI) represents the price of goods at a wholesale stage i.e. goods that are sold in bulk and traded between organizations instead of consumers. WPI is used as a measure of inflation in some economies . WPI is used as an important measure of inflation in India. Prof. Nithin Kumar S 64

65. Wholesale Price Index, also known as WPI, measures the changes in wholesale prices in India. The manufacturers and the wholesalers pay the prices based on the market demand. The Wholesale Price Index tracks the price change in commodities at the main stages before it reaches the retailers . Prof. Nithin Kumar S 65

66. Components of the Wholesale Price Index The primary articles include food particles, minerals, and vegetables. The fuel and power include energy-related products like LPG, Petrol, Diesel, CNG, etc., and The manufactured goods include those manufactured in industries like processed sugar, textile manufacturing, etc . Prof. Nithin Kumar S 66

67. Consumer Price Index Consumer Price Index or CPI is the measure of changes in the price level of a basket of consumer goods and services bought by households. CPI is a numerical estimation calculated using the rates of a sample of representative objects the prices of which are gathered periodically . Prof. Nithin Kumar S 67

68. Components of CPI Food and Beverage – 45.86 Housing – 10.07 Fuel and Light – 6.84 Clothing and Footwear – 6.53 Pan, tobacco, and intoxicants – 2.38 Miscellaneous – 28.32 Prof. Nithin Kumar S 68