demand_side_factors

8/7/2019 Demand_side_factors

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inflation

Definition

The overallgeneralupwardpricemovement ofgoods and services in an

economy(often caused by a increase in the supply ofmoney), usually as

measured by the Consumer Price Index and the Producer Price Index. Over time,

as the cost of goods and services increase, the value of a dollar is going to fall

because a person won't be able to purchase as much with that dollar as he/she

previously could. While the annualrate of inflation has fluctuated greatly over

the lasthalfcentury, ranging from nearly zero inflation to 23% inflation, the Fed

actively tries to maintain a specific rate of inflation, which is usually 2-3% but

can vary depending on circumstances. opposite ofdeflation.

NEW DELHI, March 15, 2010: Driven by increasing food prices, India's annualrate of inflation, based on the wholesale price index, rose to 9.89 percent inFebruary from 8.56 percent in the previous month, official data revealed Monday.The latest data released by the commerce ministry showed food prices jumped17.79 percent last month, while those for primary articles rose 15.54 percent.Manufactured products were up 7.42 percent. Prime Minister Manmohan Singh

on March 5 admitted in parliament that price rise was a cause of worry andassured the house that all possible steps were being taken to contain it.At its January policy review, the central bank raised its WPI inflation projection

for end-March 2010 to 8.5 percent. The Reserve Bank of India is widely expectedto raise both its benchmark lending and borrowing rates by at least 25 bps eachto 5.00 per cent and 3.50 per cent, respectively.

Fuelled by a slew of stimulus measures, GDP grew 7.9 per cent in the secondquarter of the current fiscal. However, due to the draughts, the growth dropped to6 per cent in the third quarter on back of a 2.8 per cent negative growth in thefarm output. The government has also completed its market borrowings of $9billion for the current fiscal.
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Demand side factors:

1- Increase in nominal money supply: Increase in nominal money supply withoutcorresponding increase in output increases the aggregate demand. The higher the moneysupply the higher will be the inflation.

2- Increase in disposable income: When the disposable income of the people increases, their

demand for goods and services also increases.

3- Expansion of Credit: When there's expansion in credit beyond the safe limits, it createsincrease in money supply, which causes the increased demand for goods and services in theeconomy. This phenomenon is also known as 'credit-induced inflation'.

4- Deficit Financing Policy: Deficit financing raises aggregate demand in relation to theaggregate supply. This phenomenon is known as 'deficit financing-induced inflation'.

5- Black money spending: People having black money spend money lavishly, which increasesthe demand un-necessarily, while supply remains unchanged and prices go up.

Supply side factors

1- Shortage of factors of production or inputs: Shortage of factors of production, i.e. rawmaterial, labour capital etc causes the reduced production, which causes the increase inprices.

2- Industrial Disputes: When industrial disputes come to happen, i.e. trade unions resortstrikes or employers decide lock outs etc the industrial production reduces. And as a shortsupply of goods in the market the prices go up.

3- Natural Calamities: Natural disasters, invasions, diseases etc effect the agriculturalproduction, and shortage of supply which furthers the rise in prices.

4- Artificial Scarcities: Hoarders, black marketers and speculators etc create artificial shortageto earn more profits by keeping the prices high. (in Pakistan bird flu dilemma and sugar crisesare the major examples in this regard)

5- Increase in exports (excess exports): When the country has tends to earn maximumforeign exchange and exports more and more without considering the domestic use of thecommodities, it creates a shortage of commodities at home which increases the prices. (Withreference to Pakistan, the failure of export bonus scheme during 1950's is the most commonexample of this type of cause of inflation)


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MONETARY POLICY

Let me start by welcoming the Reserve Bank of Indias (RBI) move to have a mid-quarter reviewof monetary policy from now. In a fast-changing and quite unpredictable macroeconomicenvironment, there is a need for continuous assessment and policy action. By reviewing themonetary policy every six weeks, RBI can provide a more realistic and faster response todevelopments. This will also take the surprise element out of the off-cycle actions, as noted byRBI.

Coming now to inflation, if we look at the headline index, we see that inflation has been at double-digit levels since February 2010. Latest figures show that in June 2010, headline inflation stood at10.6%. Disaggregated numbers further show that while inflation in primary articles has remainedat elevated levels for an extended period, with inflation crossing the 15% mark in recent months,

the price rise phenomenon is now spreading to other segments as well.

Data shows that non-food manufacturing inflation has seen a rapid build-up, rising from near zeroin November 2009 to 7.3% in June 2010. This increase in prices of manufactured goods can beexplained by three factors. First is the incessant increase in prices of raw materials and industrialinputs.

Second is the upward revision in wages and salaries, with several companies renegotiating theircompensation contracts to match the higher cost of living. Third and most important is therecovery in economic situation with demand holding at strong levels in the economy. This has ledto an improvement in capacity utilisation levels with some segments of industry now facingconstraints to meet the rising demand.

The RBI is understandably worried about this increasingly generalised nature of inflation. It hasmade its concern public and to clamp down inflation, it has introduced a series of quick andsuccessive policy rate hikes.

On July 2, 2010, we saw the repo and reverse repo rates being hiked by 25 bps. On July 27,2010, RBI repeated the act, but this time, the reverse repo was hiked by 50 bps against 25 bpsthat was the consensus view amongst economists who participated in Ficcis latest EconomicOutlook Survey.

With the RBI making it clear that the balance of policy stance has to shift decisively tocontaining inflation and anchoring inflationary expectations, we can pre-judge the direction inwhich monetary policy will move in the days ahead.

The question now is whether these moves will help in cooling down prices and bringing inflationback to the more acceptable 5% level. In our view, the answer is both yes and no. Let meexplain.

The tightening of monetary policy by RBI will be followed by an increase in lending rates by banksfor all kinds of borrowers. Once this happens, you will see some impact on industrial growth. Thelogic is simple: A rise in interest rate will compress both consumption and investment demandand this, in turn, will impinge on industrial activity. As a follow up, you will see some relief fromcapacity constraints and manufacturing inflation will moderate.


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In order to bring inflation to six per cent by March 2011, RBI hiked repo (short-term lending) rates by 0.25

per cent and reverse repo (borrowing rates) by 0.50 per cent.

Now, the Repo Rate stands at 5.75 per cent and Reverse Repo Rate stands at 4.5 per cent. The

new interest rates will be effective immediately.

FISCAL POLICY

A market efficiently organises various economic activities on the basis of demand and supply to

bring about coordinated economic decisions. Efficiency is understood in the sense of Pareto

optimality the impossibility of reallocating resources to make one person better off without

making anyone else worse off. But sometimes market fails to achieve this objective. One basic

reason of this failure is when some costs and/or benefits are not fully reflected in the market price.

For example, if prices do not communicate societys desire and constrains accurately, the market

would fail. Another example is when private decisions based on these prices do not generate an

efficient allocation of recourses. In essence, a market system fails because of any of the following

reasons:

Lack of or weak property rights;

Public goods and/or common property characteristics;

Externalities;

Asymmetric information.

These reasons somehow distort both the supply-side and demand-side of the market system which

is crucial for its efficient and effective functioning.

Monetary and Credit Policy

Monetary and Credit Policy is essentially managed by central bank (known by different names in

different countries; in India it is the Reserve Bank of India). In a nutshell, this policy is linked with

the control of the supply of money and its availability to the people, and the cost of money or rate

of interest to bring about economic stability in the system.
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Monetary policy can be either expansionary or contractionary. The first one increases the total

supply of money to face unemployment and recession by lowering the interest rates, and the

second one decreases it by raising interset rates to control inflation.

In essence, The Monetary Policy and Credit Policy regulates the supply of money and the cost and

availability of credit in the economy. It deals with both the lending and borrowing rates of interest

for commercial banks. The Monetary Policy aims to maintain price stability, full employment and

economic growth.

The Monetary and Credit Policy is the policy statement, traditionally announced twice a year in

India, through which the Reserve Bank of India (RBI) seeks to ensure price stability for the

economy essentially by controlling money supply, interest rates and the inflation. Money supply is

referred as M3- which indicates the level (stock) of legal currency in the economy. This policy also

contains norms for the banking and financial sector and the institutions which are governed by it.

These would be banks, financial institutions, non-banking financial institutions, money markets

foreign exchange (forex) market.

Monetary and Credit Policy uses the following terms:

Bank Rate (or the discount rate) is the minimum rate at which the Central Bank provides loans to

the commercial banks. Usually, an increase in bank rate increases the lending rates of commercial

banks. Changes in bank rate affect credit creation by banks through altering the cost of credit.

Cash Reserve Ratio: All commercial banks are required to keep a certain amount of its deposits in

cash with Reserve Bank of India. This percentage is called the Cash Reserve Ratio.

Money Supply (M3): M3 is a broad concept of money supply which includes net time deposits

(fixed deposits), savings deposits with post office saving banks and all the components of M1 (which

equals the sum of currency with the public, demand deposits with the public and other deposits with

the public). In other words, M3 refers to the total volume of money circulating in the economy.

Statutory Liquidity Ratio: Banks in India are required to maintain 25 per cent of their demand

and time liabilities in government securities and certain approved securities. These are collectively

known as SLR securities.

Repo Rate: A repurchase agreement or ready forward deal is a secured short-term (usually 15

days) loan by one bank to another against government securities. The Repo rate is the rate at which

at which the RBI repurchases government securities from the commercial banks. For pumping in

short-term liquidity into the system. The Reverse Repo Rate is the rate at which banks park their

short-term excess liquidity with the RBI.

Open Market Operations: This relates to the buying and selling of securities by the Reserve Bank

of India in open market operations for purposes of credit control. When there is inflation, RBI sells

securities to mop up the excess money in the market, and when inflation is very low, RBI buys

securities for increasing the supply of money.
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inflation

Definition

Theoverallgeneralupwardpricemovementofgoodsandservicesin aneconomy(oftencaused by aincreasein thesupplyofmoney), usually as measured by theConsumer

Price Indexand theProducer Price Index. Over time, as thecostof goods and

services increase, thevalueof adollaris going tofallbecause apersonwon't

beabletopurchaseas much with that dollar as he/she previously could. While

theannualrate of inflationhas fluctuated greatly over thelasthalfcentury, ranging

from nearlyzeroinflation to 23% inflation, theFedactively tries tomaintaina

specificrateof inflation, which is usually 2-3% but can vary

dependingoncircumstances. opposite ofdeflation.

NEW DELHI, March 15, 2010: Driven by increasing food prices, India's annualrate of inflation, based on the wholesale price index, rose to 9.89 percent inFebruary from 8.56 percent in the previous month, official data revealed Monday.The latest data released by the commerce ministry showed food prices jumped17.79 percent last month, while those for primary articles rose 15.54 percent.Manufactured products were up 7.42 percent. Prime Minister Manmohan Singhon March 5 admitted in parliament that price rise was a cause of worry andassured the house that all possible steps were being taken to contain it.

At its January policy review, the central bank raised its WPI inflation projectionfor end-March 2010 to 8.5 percent. The Reserve Bank of India is widely expectedto raise both its benchmark lending and borrowing rates by at least 25 bps eachto 5.00 per cent and 3.50 per cent, respectively.

Fuelled by a slew of stimulus measures, GDP grew 7.9 per cent in the secondquarter of the current fiscal. However, due to the draughts, the growth dropped to6 per cent in the third quarter on back of a 2.8 per cent negative growth in the
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farm output. The government has also completed its market borrowings of $9billion for the current fiscal.

demand_side_factors

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