Inflation

Inflation represents a persistent increase in the general price level in a country over time. This phenomenon can manifest as either monetary inflation or price inflation. During inflationary periods, there is an uptick in money supply, causing the currency to lose purchasing power, leading to price hikes in goods and services. Economic cycles typically experience phases of inflation, deflation, and stagflation, each with unique impacts on the economy.

Learning Outcomes

1. Identify different types of inflation.
2. Analyze the causes and effects of inflation.
3. Differentiate between demand-side and supply-side inflation.
4. Discuss various measures used to check inflation.
5. Recognize inflation measurement indices such as WPI and CPI.

Types of Inflation

Inflation varies in intensity and speed. Understanding its types helps in policy formulation and economic planning.

1. Low Inflation/Creeping Inflation: A slow and predictable rise in prices, usually within a single-digit range over an extended period.
2. Galloping Inflation: Characterized by double or triple-digit increases. Also called hopping, jumping, or running inflation.
3. Hyperinflation: An extreme, accelerating inflation that could have annual rates in the millions. Historical examples include post-World War I Germany and Bolivia in 1985.
4. Bottleneck Inflation: Occurs when a drastic supply reduction happens while demand remains unchanged.

Causes of Inflation

Inflation results from a mismatch between demand and supply. When demand outstrips supply, inflation ensues. Causes can stem from demand-side or supply-side factors.

Demand-Side Inflation (Demand-Pull Inflation)

1. Increase in Public Expenditure: Government spending, especially with high fiscal deficits, boosts overall demand.
2. Loose Monetary Policy: Central banks’ low-interest rates increase consumption and money supply.
3. Rapid GDP Growth: Higher employment and wages lead to increased purchasing power.
4. Population Growth: Larger populations drive up demand for goods and services.
5. Exchange Rate Depreciation: Reduced imports and increased exports lead to higher domestic demand.
6. Reduction in Direct Taxes: More disposable income for households results in higher spending.
7. Commodity Speculation: Speculative buying in commodity markets escalates demand.

Supply-Side Inflation (Cost-Push Inflation)

1. Backward Agricultural Sector: Inadequate food production causes supply shortfalls.
2. Inefficient Infrastructure: Poor storage, transportation, and marketing reduce effective supply.
3. Hoarding by Traders: Artificial scarcity created by hoarding inflates prices.
4. Rising Input Costs: Increased prices of crude oil, fertilizers, labor, and imported materials.
5. Central Bank Credit Squeeze: Higher capital costs restrict supply.
6. Market Monopoly and Cartelization: Single or grouped suppliers fix prices arbitrarily to maximize profits.
7. Profit Push by Management: Companies increase prices to boost profits, further fueling inflation.

Important Note: Differentiating between demand-side and supply-side inflation is complex; certain factors may contribute to both sides.

Effects of Inflation

The impact of inflation varies across different community groups, affecting income distribution, wealth, and overall economic activity.

1. Business Community: Entrepreneurs and businesses benefit from rising prices due to increased inventory values and faster-rising product prices compared to production costs.
2. Fixed Income Groups: Wage earners and salaried individuals suffer since wages rarely keep pace with inflation, reducing real income and purchasing power.
3. Farmers: Typically gain as they can command higher prices for their produce.
4. Investors: Fixed-interest security holders lose out, whereas equity investors may gain due to higher corporate profits and dividends.

Important Note: Inflation reduces gross domestic savings, lowers capital formation, and diminishes long-term economic growth.

Measures of Inflation

Inflation is gauged using several indices, primarily:

1. Wholesale Price Index (WPI): Tracks wholesale price changes weekly. It links the current year’s average wholesale prices with a base year’s prices.
2. Consumer Price Index (CPI): Measures monthly changes in retail prices, covering both goods and services, thus reflecting consumers’ cost of living.

WPI vs. CPI: A Comparative Table

Inflation-Related Concepts

1. Deflation: General decline in prices, often due to reduced money or credit supply. It can lead to economic depression due to lower demand and increased unemployment.
2. Stagflation: Occurs when the economy stagnates with high inflation and unemployment, creating a cycle of low growth and rising prices.
3. Disinflation: A decrease in the inflation rate over time, though prices may still be increasing.
4. Reflation: Measures taken to reintroduce inflation into an economy experiencing deflation to stimulate growth.

New Series WPI

The revised WPI includes 697 items, adding products like radish, natural gas, and conveyor belts while removing outdated items like khandsari and video CD players.

CPI and Its New Indices

CPI now includes a broader range of goods and services reflecting living conditions. The Central Statistical Office (CSO) has introduced CPI (Urban) and CPI (Rural) to encompass all population segments.

Concept: GDP Deflator represents the ratio between GDP at current and constant prices, encompassing all goods and services produced, thus offering a comprehensive price behavior measure.

Inflation Control Measures

Inflation control requires combined efforts from the Reserve Bank of India (RBI), government ministries, and inter-ministerial advisory groups. Key measures include:

Fiscal Measures

1. Public Expenditure: Increase developmental spending to boost supply.
2. Tax Incentives: Introduce tax breaks to stimulate supply.

Administrative Measures

1. Remove Levy Obligations: For imported materials.
2. Ban Exports: On scarce goods.
3. Control Central Issue Prices: For essential commodities like rice and wheat.
4. Open Market Sales: Utilize schemes to manage supply and prices.

Monetary Measures

Implemented by the RBI through monetary policy reviews, aimed at regulating money supply to stabilize the economy.

Important Note: The Inter-Ministerial Group (IMG) recommends FDI in multi-brand retail and APMC Act amendments to streamline supply chains and benefit farmers and consumers.

MCQ for Review

What is the main difference between WPI and PPI?

1. WPI covers only goods, while PPI covers both goods and services.
2. WPI includes mark-ups and taxes; PPI excludes taxes.
3. WPI is calculated monthly, while PPI is calculated yearly.
4. WPI reflects retail prices; PPI reflects wholesale prices.
   Answer: 2. WPI includes mark-ups and taxes; PPI excludes taxes.