Download - 5. concept of inflation & stagflation
CONCEPT OF INFLATION & STAGFLATION
Inflation Inflation refers to general rise in prices According to Prof. Crowther “inflation is a
state in which the value of money is falling i.e. Prices are rising”
There are various types of Inflation
Types of Inflation Basis of Rate Inflation
Creeping Inflation Walking Inflation Running Inflation Galloping Inflation Hyper Inflation
Basis of Govt Intervention Basis of Coverage Time Period
Basis of Causes Credit Scarcity Deficit Currency Profit Tax Wage Foreign trade Stagflation
Types of Inflation – Basis of Rate Inflation
Creeping Inflation – 3% p.a. , mild inflation, tolerable
Walking Inflation – 3-6% p.a. – should be taken care of not converting into running inflation
Running Inflation – 10-20% p.a. Galloping Inflation – More than 20% - serious
problem – will harm all sectors of economy
Types of Inflation – Basis of Rate Inflation
Hyper Inflation price rise will be at every moment – change in price will be
difficult to measure In terms of %, it would be more than 1000% per year Austria, Hungary, Poland, Germany & former USSR experienced
hyper inflation during World War I Germany experienced severe hyper inflation in 1924 Prof Samuelson, described hyper inflation in a statement, “we
used to go to store with money in our pockets & come home with food in our baskets, now we go with money in our baskets & return with foods in our pocket
Hyper inflation is a serious problem
Types of Inflation Basis of Govt Intervention – Open, Repressed Inflation Basis of Coverage – Sporadic (in 1 particular sector
only) Comprehensive (Covers entire economy) Time Period – Peacetime, War Time, Post war time Basis of causes
Credit Inflation – banks create credit – more money supply – more demand for goods & services – if supply of goods & services is less than demand then price rises
Basis of Causes Scarcity Inflation – scarcity of goods & services due to
fall in production or artificial hoarding Deficit Inflation – when BOP is in deficit – central bank
resorts to deficit financing i.e. creation of new money by launching new projects – leading to more supply of money – more demand of goods – hence rise in price
Currency Inflation – supply of money is more than supply of goods & services hence price rise
Basis of Causes Profit Inflation – Excess profits earned by
entrepreneurs – inflation causes them to earn more profits – thereby investing more – more supply of money – more demand of goods – hence rise in price
Wage / Cost Inflation – price rise due to rise in cost of production – costs includes wages, rent, interest etc. – wage is most imp factor
Basis of Causes Foreign Trade induced Inflation – export induced -
international demand increases but the supply is not able to match demand – price rises Import induced – rise in price of imported components –
rise in price of final product Stagflation – emerged post WW 2, situation where high
rise in price with high rate of unemployment – co-existence of stagnation & inflation called as Jobless Growth
Stagflation In India In India, stagflation refers to a situation of slow growth rate
or recession along with high rate of inflation India experienced stagflation from 1991-1994 Factors
responsible for stagflation were Decline in public sector investment, restrictions on imports,
high rate of interest, increase in money supply, rise in price of oil & other prods like coal, steel, cement etc.
Above factors resulted in slow growth rate & high inflation
Stagflation In India Govt tried curb inflation by reducing money
supply in mkt, reducing fiscal deficit to control demand & boost supply
Due to govt efforts, growth rate improved lowering the rate of inflation & unemployment
Since 2014, oil prices have reduced leading to fall in rate of inflation
Demand Pull Inflation Developed by J.M. Keynes It arises due to aggregate demand of goods & services is
more than its supply Demand may be more, due to increase in money supply It is associated with full level of employment i.e. all the
resources of nations are completely employed In such scenario, demand increases as money supply
has increased in market However, Supply cannot be increased as resources are
fully utilized
Cost Push Inflation Refers to rise in price level due to rise in cost of production It may occur due to rise in wage rate or due to rise in rate of
profit. Wage is a major component in cost Employers try to pass on this additional cost to the customers
by increasing price thereby increasing cost of living Workers will further ask for revision in wage as cost of living is
increasing Inflation may also occur when profit margin is increased i.e.
Profits being determined on the basis of mark-up over cost o production – known as mark up inflation
Causes of Inflation
Expansion of Money Supply
Increase in Disposable Inc External Demand (Export)
Rise in Expenditure Future Expectations
Inadequate Resources Hoarding & black
Marketing Natural Calamities Exports Full Employment
Situation
Factors influencing Demand Side
Factors influencing Supply Side
Effects of Inflation on Production Adverse effect on Capital Formation – Reduction in savings as
cost of living rises – less savings will lead to less investment & poor capital formation
Production distortion – inflation distorts production by diverting resources to the production of non-essential goods (higher profit margin) from essential goods (lower profit margin)
Hoarding & black Marketing Speculation Profit Orientation & Quality Deterioration Erosion in the value of money
Effect of Inflation on Distribution of Income &
Wealth Cost of production of goods tend to increase during inflation, however,
price rises more than rise in cost of production thereby increasing profit
During inflation, businessmen, traders, speculators gain maximum Worst affected section is the fixed income group When worker class tries to get increment on their current salary, it
results in cost push inflation Debtors & Creditors are affected differently – Debtors benefit as when
they are repaying the loan the value of money has fallen and creditors lose as the money received by them is not the same in terms of real money
Effect of Inflation on Distribution of Income &
Wealth People who invest in shares or bonds will gain more due to higher
profits earned by firms On the other hand, people investing in assets reaping fixed income
(Fixed Deposit etc) will be in loss Farmers benefits from inflation as they would earn more on the
products produced. It will also increase the cost of production but rise in price is more than rise in cost.
However, the advantage is gained by rich farmers than poor farmers Thus, inflation redistributes income in favour of businessmen, debtors
& farmers at the expense of fixed income group, creditors & consumers
Social & Political Effects of Inflation
Inflation helps rich to become richer & makes poor more poorer
Inequality widens, leading to social injustice Inflation helps businessmen & traders to sell sub-
std products at higher rates, black marketing etc. People start losing confidence in govt if it does not
intervene to curb the inflation thus creating issues in social harmony & political stability
Measures to Control Inflation
Various measures are required to control inflation Inflation is caused due to disequilibrium in demand
& supply, hence measures are directed towards influencing them
Following are the measures adopted to curb inflation Monetary Measures Fiscal Measures Other Measures
Monetary Measures Inflation arises due to more money supply in market
hence central bank tries to control the money supply by controlling the credit created by commercial banks
Central bank uses 2 methods – quantitative & qualitative Quantitative Method – controlling the volume of credit in
market Qualitative Method – controlling the direction of credit by
consumer credit regulation, changing the margin requirements
Fiscal Measure Measures related to taxation, public expenditure &
public debt is known as fiscal measures. Govt uses these factors to curb inflation
Reduce demand by increasing taxes of goods & services, increasing direct tax on income
Reduction in public expenditure Public Debt – borrowing money from public will reduce
the money supply in market thereby reducing inflation
Other Measures Incentives are offered by govt to producers
of essential items Efforts are undertaken to increase the
supply of goods (so that excess demand can be managed)
Controlling the prices of essential items Import of essential items if acute shortage
(depends on position of BOP)
Deflation Refers to a situation where prices keep
declining along with fall in employment, output & income
Opposite of inflation Decline in prices could be due to govt
measures, however it would not be termed as deflation
Deflation only occurs when the fall in price is accompanied by decline in output, employment etc.
Questions 1. Explain inflation and its various types 2. Stagflation in India (including Demand Pull & Cost Push
Inflation)3. Causes of Inflation 4. Effect of Inflation (Any 2 can come for a long answer or
any 1 can come for Short Note) 5. Measures to Control Inflation (Any 1 can come for Short
Note) 6. Deflation – Short Note