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INFLATION:

Inflation is defined as the increase in the general level of prices of goods and services in an

economy over the period of time

Inflation can be positive and it can also be negative. Inflation is very bad for the economy of a

country ifits too high a country should have a minimum percentage of inflation for their stable

economy. In the period of inflation the prices of all the products and services in the economy will

rise with the increase in the money supply. The major cause of inflation is the increase in the

money supply in the economy. A country should have a minimum percentage of inflation if a

country has negative inflation that is called deflation which is worst than inflation.

ECONOMY OF INDIA:

The economy of India is the ninth largest economy in the world by the nominal GDP

(Gross Domestic Product) and it ranks on the fourth largest by Purchasing Power Parity (PPP).

The per capita GDP is $3,339 in 2010. The GDP growth rate of India is 7.7%.

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This graph shows that there is a decrease in the GDP growth rate of India from the last few years.

The GDP growth rate of India was at its peak in the year 2006 which was 10.1% and now the

GDP has been decreased to 7.7% this decrease is not good for the economy of the country.

INFLATION IN INDIA:

India has a population of more than 100 Million. India has been facing inflation from many

years. The inflation rate in India is 9.22% which was last reported in July 2011. In India the

average inflation rate from the year 1969 to 2010 is 7.99 %. The inflation rate of India reached at

a historical high of 34.68% in the year 1974 and the lowest was in the year of 1976 which was

reported as -11.31%. It means that in the year 1976 India faced deflation in the country which is

worst than inflation.

The inflation rate in India was last reported to be 9.22 percent in July of 2011. Since

the year of 1969 till the year of 2010, the average inflation rate in India was 7.99 percent. The

inflation rate of the country reached an historical high of 34.68 percent during the month of

September in the year of 1974. The lowest was recorded in the month of May in the year of

1976. It was reported to be as low as -11.31.

INFLATION RATE GRAPH FROM THE YEAR 1990 TO 2011

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This graph shows the inflation rate in inda from the year 1990 to 2011. In this graph the highest

rate of inflation in India was in year 1998 which was 19% .

IMPACT OF INFLATION IN INDIA:

Inflation shows great impacts on the economy of a country some times these changes are positive

and some times they goes negative. Inflation in India is very high as compare to some other

countries. The economy of India is boosting very fast and there is always danger of getting high

inflation in the country. Following are the impacts of inflation on the economy of India.

EFFECTS OF INFLATION ON INDIA:

INTEREST RATES:

When ever there is inflation in the country its effects directly hits the interest rates

in the country. When the rate of inflation is high in the country the interest rate will also be

higher in the country. Currently there is 8% inflation in India and they have 7% interest rate.

This is very higher as compare to other countries.

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When the bank interest rate increase people will stop borrowing money from banks because thy have

to pay a large number of interest on the borrowings. In India poor people cannot borrow money from

bank because of the high interest rate. When the interest rate increase people will stop borrowing

money which will move the demand curve of interest rate to leftwards shows a decrease in the

demand of loans from banks.

This graph shows the movement of demand curve to leftwards.

http://www.worldjute.com/inflation.html

INCREASE IN PRICES OF GOOD AND SERVICES:

Inflation means Increase in the prices of good and services when inflation hits India the prices of

good rises to a high level. In India when the inflation was too high the prices of good are also too

high. Now India has a high percentage of food inflation which is 9.13% in 2011. This is because

of inflation as the prices of goods are higher in inflation. People cannot buy any thing every thing

in the economy will be very expensive for purchase. In India mostly people live under the

poverty line so the increase in the prices of goods will make negative effects on the purchase of

poor people.

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This picture shows that change in the prices of basic commodities in India during the inflation

period of 2009.

http://seekingalpha.com/article/179191-food-inflation-in-india-causes-solutions

INVESTMENT:

When the prices of goods increase in the economy then people have to spend more and they

cannot save any money for investment or savings. In inflation the investment in the economywill decrease which can also effect the economic growth of the country.

emand-pull inflation

Demand-pull inflation is likely when there is full employment of resources and aggregate demand isincreasing at a time when SRAS is inelastic. This is shown in the next diagram:

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In the diagram above we see a large outward shift in AD. This takes the equilibrium level of nationaloutput beyond full-capacity national income (Yfc) creating a positive output gap. This would then putupward pressure on wage and raw material costs leading the SRAS curve to shift inward and causingreal output and incomes to contract back towards Yfc (the long run equilibrium for the economy) butnow with a higher general price level (i.e. there has been some inflation).

The main causes of demand-pull inflation

Demand pull inflation is largely the result of the level of AD being allowed to grow too fast comparedto what the supply-side capacity can meet. The result is excess demand for goods and services andpressure on businesses to raise prices in order to increase their profit margins.

Possible causes of demand-pull inflation include:

1. A depreciation of the exchange rate which increases the price of imports and reduces theforeign price of UK exports. If consumers buy fewer imports, while exports grow, AD in willrise and there may be a multiplier effect on the level of demand and output

2. Higher demand from a fiscal stimulus e.g. via a reduction in direct or indirect taxation or

higher government spending. If direct taxes are reduced, consumers will have more disposableincome causing demand to rise. Higher government spending and increased governmentborrowing feeds through directly into extra demand in the circular flow

3. Monetary stimulus to the economy: A fall in interest rates may stimulate too much demand for example in raising demand for loans or in causing a sharp rise in house price inflation

4. Faster economic growth in other countries providing a boost to UK exports overseas. Exportsales provide an extra flow of income and spending into the UK circular flow so what ishappening to the economic cycles of other countries definitely affects the UK

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Cost-push inflation

Cost-push inflation occurs when firms respond to rising costs, by increasing prices to protect theirprofit margins. There are many reasons why costs might rise:

1. Component costs: e.g. an increase in the prices of raw materials and other components used

in the production processes of different industries. This might be because of a rise in worldcommodity prices such as oil, copper and agricultural products used in food processing

2. Rising labour costs - caused by wage increases, which are greater than improvements inproductivity. Wage costs often rise when unemployment is low (skilled workers become scarceand this can drive pay levels higher) and also when people expect higher inflation so they bidfor higher pay claims in order to protect their real incomes. Expectations of inflation areimportant in shaping what actually happens to inflation!

3. Higher indirect taxes imposed by the government for example a rise in the specific duty onalcohol and cigarettes, an increase in fuel duties or a rise in the standard rate of Value AddedTax. Depending on the price elasticity of demand and supply for their products, suppliers maychoose to pass on the burden of the tax onto consumers

Cost-push inflation can be illustrated by an inward shift of the short run aggregate supply curve. The

fall in SRAS causes a contraction of national output together with a rise in the level of prices.

Which government policies are most effective in reducing inflation?

Most governments now give a high priority to keeping control of inflation. It has become one of thedominant objectives of macroeconomic policy.

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Inflation can be reduced by policies that (i) slow down the growth of AD or (ii) boost the rate of growthof aggregate supply (AS). The main anti-inflation controls available to a government are:

1. Fiscal Policy: If the government believes that AD is too high, it may reduce its own spending onpublic and merit goods or welfare payments. Or it can choose to raise direct taxes, leading to areduction in disposable income. Normally when the government wants to tighten fiscal

policyto control inflation, it will seek to cut spending or raise tax revenues so thatgovernment borrowing (the budget deficit) is reduced. This helps to take money out of thecircular flow of income and spending

2. Monetary Policy:A tightening of monetary policy involves higher interest rates to reduceconsumer and investment spending. Monetary policy is now in the hand of the Bank of England it decides on interest rates each month.

3. Supply side economic policies: Supply side policies include those that seek toincreaseproductivity, competition and innovation all of which can maintain lower prices.

The most appropriate way to control inflation in the short term is for the British government and theBank of England to keep control of aggregate demand to a level consistent with our productivecapacity. The consensus among economists is that AD is probably better controlled through the use ofmonetary policy rather than an over-reliance on using fiscal policy as an instrument of demand-

management. But in the long run, it is the growth of a countrys supply-side productive potential thatgives an economy the flexibility to grow without suffering from acceleration in cost and price inflation.

EXCHANGE RATES:

SOCIAL PROBLEMS IN COUNTRY

UNEMPLOYMENT

INCREASE IN PRICES OF GOODS AND SERVICES

DEMAND PULL EFFECT SUPPLY OF GOODS AND SERVICES

I) Investment:If the price of goods increases and people have to compensate for the increase in price, they

usually make use of theirsavings. In the event when savings are depleted, fund for investment

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is no longer available. An individual tends to invest, only if savings of an individual is strong and

has sufficient money to meet his daily needs.

II) Interest rates:Whenever inflation reigns supreme, it is a well known fact that the value of money goes down.

This leads to decline in thepurchasing power. In the event, when the rate of inflation is high, theinterest rates also rise. With increase in both parameters, cost of goods will not remain the

same and consequently people will have to shell out more money for the same goods.

III) Exchange rates:Inflation and economic growth are affected by exchange rates as well. Exchange rates denote

thevalue ofmoneyprevailing in different countries. High rate of inflation causes severe

fluctuations in exchange rates. This adversely affects trade (export and import), important

business transaction across borders, value of money also changes.

IV) Unemployment:Growth of a nation depends to a large extent on employment. If rate of inflation is high,unemployment rate is low and vice versa. This theory is propounded by economist William

Philips and this gave rise to the Philips Curve.

Effects

The case for maintaining price stabilityIt is clear that very high inflation in extreme cases hyperinflation can lead to a breakdown of the

economy. There is now a considerable body of evidence that inflation and output growth are negativelycorrelated in high-inflation countries. For inflation rates in single figures, the impact of inflation ongrowth is less clear.Source: Mervyn King, Governor of the Bank of England

In explaining and assessing the costs of inflation, we must be careful to distinguish betweendifferentdegrees of inflation, since low and stable inflation is perceived to have less of a damaging effect thanhyper-inflation where prices are out of control. Another important part of your evaluation is to beaware that inflation will have differing effects both on individuals and also the performance of theeconomy as a whole.

Impact of Inflation on Savers:

Inflation leads to a rise in the general price level so that money loses its value. When inflation is high,people may lose confidence in money as the real value of savings is severely reduced. Savers will loseout if nominal interest rates are lower than inflation leading to negative real interest rates. Forexample a saver might receive a 3% nominal rate of interest on his/her deposit account, but if theannual rate of inflation is 5%, then the real rate of interest on savings is -2%.

Inflation Expectations and Wage Demands

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Inflation can get out of control because price increases lead to higher wage demands as people try tomaintain their real living standards. Businesses then increase prices to maintain profits and higherprices then put further pressure on wages. This process is known as a wage-price spiral. Risinginflation leads to a build-up of inflation expectations that can worsen the trade-off betweenunemployment and inflation.

Arbitrary Re-Distributions of Income

Inflation tends to hurt those employees in jobs with poor bargaining positions in the labour market -for example people in low paid jobs with little or no trade union protection may see the real value oftheir pay fall. Inflation can also favour borrowers at the expense of savers as inflation erodes the realvalue of existing debts. And, the rate of interest on loans may not cover the rate of inflation. When thereal rate of interest is negative, savers lose out at the expense of borrowers.

Business Planning and Investment

More generally, inflation can disrupt business planning. Budgeting becomes difficult because of theuncertainty created by rising inflation of both prices and costs - and this may reduce planned capitalinvestment spending. Lower investment then has a detrimental effect on the economys long run

growth potential

Competitiveness and Unemployment

Inflation is a possible cause of higher unemployment in the medium term if one country experiences amuch higher rate of inflation than another, leading to a loss of international competitiveness and asubsequent worsening of their trade performance. If inflation in the UK is persistently above our majortrading partners, British exporters may struggle to maintain their share in overseas markets and importpenetration into the UK domestic market will grow. Both trends could lead to a worsening balance ofpayments. The UK government believes that monetary stability (i.e. low inflation) is a precondition forsustained economic expansion. As the chart below demonstrates, the UK has made progress inreducing the volatility of its inflation rate in the last decade. The era of high and volatile inflation mayhave come to an end

Causes

CAUSES OF INFLATION

There are a few different reasons that can account for the inflation in our goods and services; let's review a few

of them.

Demand-pull inflation refers to the idea that the economy actual demands more goods and services than

available. This shortage of supply enables sellers to raise prices until an equilibrium is put in place between

supply and demand.

The cost-push theory , also known as "supply shock inflation", suggests that shortages or shocks to the

available supply of a certain good or product will cause a ripple effect through the economy by raising prices

through the supply chain from the producer to the consumer. You can readily see this in oil markets. When

OPEC reduces oil supply, prices are artificially driven up and result in higher prices at the pump.

Money supply plays a large role in inflationary pressure as well. Monetarist economists believe that iftheFederal Reservedoes not control the money supply adequately, it may actually grow at a rate faster than

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that of the potential output in the economy, or real GDP. The belief is that this will drive up prices and hence,

inflation. Low interest rates correspond with a high levels of money supply and allow for more investment in

big business and new ideas which eventually leads to unsustainable levels of inflation as cheap money is

available. Thecredit crisis of 2007is a very good example of this at work.

Inflation can artificially be created through a circular increase in wage earners demands and then the

subsequent increase in producer costs which will drive up the prices of their goods and services. This will thentranslate back into higher prices for the wage earners or consumers. As demands go higher from each side,

inflation will continue to rise.

Causes and effects

Causes of Inflation

1. Over- Expansion of Money Supply: Many a times a remarkable degree of correlation between the

increase in money and rise in the price level may be observed. The Central Bank (Indias RBI) shouldmaintain a balance between money supply and production and supply of goods and services in the

economy. Money supply exceeds the availability of goods and services in the economy, it would lead to

inflation.

2. Increase in Population: Increase in population leads to increased demand for goods and services. If

supply of commodities are short, increased demand will lead to increase in price and inflation.

3. Expansion of Bank Credit: Rapid expansion of bank credit is also responsible for the inflationary trend in

a country.

4. Deficit Financing: Deficit financing means spending more than revenue. In this case government of India

accepts more amount of money from the Reserve Bank India (RBI) to spend for undertaking public

projects and only the government of India can practice deficit financing in India. The high doses of deficit

financing which may cause reckless spending, may also contribute to the growth of the inflationary spiral

in a country.

5. High Indirect Taxes: Incidence of high commodity taxation. Prices tend to rise on account of high excise

duties imposed by the Government on raw materials and essentials.

6. Black Money: It is widely condemned that black money in the hands of tax evaders and black marketers

as an important source of inflation in a country. Black money encourages lavish spending, which causes

excess demand and a rise in prices.

7. Poor Performance of Farm Sector: If agricultural production especially foodgrains production is very low,

it would lead to shortage of foodgrains, will lead to inflation.

8. High Administrative Pricing

9. Other reasons are capital bottleneck, entrepreneurial bottlenecks, infrastructural bottlenecks and foreign

exchange bottlenecks.

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Effects of Inflation

1. Effects of Inflation on Business Community: Inflation is welcomed by entrepreneurs and businessmen

because they stand to profit by rising prices. They find that the value of their inventories and stock of

goods is rising in money terms. They also find that prices are rising faster than the costs of production,

so that their profit is greatly enhanced.

2. Fixed Income Groups: Inflation hits wage-earners and salaried people very hard. Although wage-

earners, by the grace of trade unions, can chase galloping prices, they seldom win the race. Since

wages do not rise at the same rate and at the same time as the general price level, the cost of living

index rises, and the real income of the wage earner decreases.

3. Farmers: Farmers usually gain during inflation, because they can get better prices for their harvest

during inflation

4. Investors: Those who invest in debentures and fixed-interest bearing securities, bonds, etc, lose during

inflation. However, investors in equities benefit because more dividend is yielded on account of high

profit made by joint-stock companies during inflation.

5. Inflation will lead to deterioration of gross domestic savings and less capital formation in the economy

and less long term economic growth rate of the economy.

On March 19, 2010, the Reserve Bank of India raised its benchmark reverse repurchase

rate to 3.5% percent, after this rate touched record lows of 3.25%. The repurchase rate

was raised to 5% from 4.75% as well, in an attempt to curb Indian inflation.

Indias 2009-10 Economic Survey Report suggests a high double-digit increase in food

inflation, with signs of inflation spreading to various other sectors as well. The Deputy

Governor of the Reserve Bank of India, however, expressed his optimism in March 2010

about an imminent easing of Indian wholesale price index-based inflation, on the back

of falling oil and food prices.

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For 2009, Indian inflation stood at 11.49% Y-o-Y. This rate reflects the general increase

in prices, taking into account the purchasing power of the common man. According to

the Economic Survey Report for 2009-10, economic growth decelerated to 6.7% in

2008-09, from 9% in 2007-08. The economy is expected to grow by 8.7% in 2010-11,

with a return to a growth rate of 9% in 2011-12.

The Indian method for calculating inflation, the Wholesale Price Index, is different from

the rest of world. Each week, the wholesale price of a set of 435 goods is calculated by

the Indian government. Since these are wholesale prices, the actual prices paid by

consumers are far higher.

In times of rising inflation, this also means that the cost of living increases are much

higher for the populace. Cooking gas prices, for example, have increased by around

20% in 2008.

With most of Indias vast population living close to or below the poverty line, inflation

acts as a Poor Mans Tax. This effect is amplified when food prices rise, since food

represents more than half of the expenditure of this group.

The dramatic increase in inflation will have both economic and political implications for

the government, with an election due within the year.

Economic growth in emerging markets has slowed but is far from over. With the BRIC

countries (Brazil, Russia, India and China) alone accounting for more than 3 billion

people, and with these people consuming more resources every year, it is likely that

higher inflation rates will be with us for a good while yet - and that is worrying news for

the government of India.

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Body:

Impact 3

Causes 3

Steps taken by government 4

Recommendations

Conclusion

To stop inflatonBut the current high wholesale price index (WPI) inflation follows prolonged cost shocks and

a period of very low inflation. This low base overstates inflation. Policy should rather reduce

inflationary expectations without hurting the supply response.

Supply response

The supply response is especially important since India is in a catch-up growth

phase.Investment is occurring to relieve specific bottlenecks.

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Data fromIndias Central Statistical Organisation(CSO) shows that fixed investment has

remained above pre-crisis levels of 32 per cent of GDP. There is a sharp rise in the

production of capital goods. Continuing high investment implies there cannot be a large

excess of demand over capacity. Good growth and sales help spread manufacturing costs. If

productivity rises, the price-line can be held. A good monsoon after a bad one should see a

sharp jump in agricultural production and softening of food prices. Inflation in primaryarticles will fall from this month onwards because of the base effect and manufactured

goods inflation from November.

Butwages and commodity pricesare pushing up costs. Sustained high food price inflation

raises wages, since food is still above 50 per cent of the average consumer basket. That

procurement prices have held steady this year, after excessive hikes in the past few years,

will provide some relief.

But over the longer term, structural measures, such as better infrastructure and

empowering more private initiatives, are required to improve agricultural supply response.

That theNational Rural Employment Guarantee Scheme(NREGA) has raised rural wages is

a good thing, but the emphasis has been on employment and not productivity, although ithas the potential to raise both.

A wage rise exceeding that in agricultural productivity raises food prices. Or else rupee

appreciation is required to let wages rise without inflation. Prices normally are sticky

downwards. So, with monetary accommodation, a relative price change raises the general

price level. What goes up doesnt readily come down except for commodities. But in India

administered prices impart an upward bias even for food and fuel.

The petrol price decontrol was required prices will now be free to fall as well as rise. But

the timing of the price rise, when inflation is dangerously high, is unfortunate.

Past oil price hikes have not led to sustained inflation because they either followed or led to

severe monetary tightening. The attempt to conserve the macroeconomic stimulus can be

consistent with falling inflation only if it enables a supply response.

Post-reform India has had loose fiscal and tight monetary policy. Direct subsidies created

hidden indirect costs and raised debt. But inflation harms electoral prospects, so instead of

inflating debt away, a severe monetary tightening would be imposed. There would be a

large sacrifice of output, but little reduction in chronic cost-driven inflation.

Fiscal consolidation

The government now seems to be trying abetter combination: Imposing fiscal consolidation

so monetary policy can be more accommodative. Lower debt, deficits and interest rates are

useful attributes for a more open economy to have. But rather than raise tax rates thatpush up prices and costs, a better approach to fiscal consolidation is to reduce wasteful

government expenditure. Plugging leakages and cutting allocations in areas where budgets

have not been spent would create better incentives to spend.

The government has a poor record in spending effectively. Tax revenues have started rising

again with growth, but this boom should not be squandered like the last one. The

contribution of economic growth was 55 per cent and of spending cuts was 35 per cent to

Canadas successful deficit reduction in the 1990s.

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Monetary policy

A sharp rise in interest rates has severe consequences. We saw the collapse in industry

following such a rise in the late 1990s and in July 2008. Policy should rather follow a path of

gradual rise in interest rates conditional on inflation. The knowledge of future rise will

reduce inflationary expectations, if combined with action to reduce costs.

A short-term nominal exchange rate appreciation reduces costs. This can bevery useful to

contain a temporary spike in oil or food prices and will become more effective as petrol

prices are free and food prices reflect border prices. Today, the price of Washington apples

determines that of Indian apples.

The current depreciation runs counter to the attempt to reduce inflation. Changing one

exchange rate prevents thousands of nominal price changes that then become sticky and

persist, requiring painful prolonged adjustment. Small steps give the freedom to respond to

evolving circumstances. But to walk with baby steps one must start early and coordinate

action over several fronts.

Ashima Goyal is a professor of economics at the Indira Gandhi Institute of Developmental

Research (IGIDR), Mumbai.

http://www.eastasiaforum.org/2010/07/30/india-controlling-inflation-without-hurting-growth/

more correct inflation is persistent rise in the general price level rather than a once-for-all rise in it, while

deflation is persistent falling price. A situation is described as inflationary when either the prices or the

supply of money are rising, but in practice both will rise together. These days economies of all countries

whether underdeveloped, developing as well developed suffers from inflation. Inflation or persistent rising

prices are major problem today in world. Because of many reasons, first, the rate of inflation these years

are much high than experienced earlier periods. Second, Inflation in these years coexists with high rate of

unemployment, which is a new phenomenon and made it difficult to control inflation.

An inflationary situation is where there is too much money chasing too few goods. As products/services

are scarce in relation to the money available in the hands of buyers, prices of the products/services rise to

adjust for the larger quantum of money chasing them.

Read More:Definition of inflation and its types

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Inflation in Indian Context

Inflation is no stranger to the Indian economy. The Indian economy has been registering stupendous

growth after the liberalization of Indian economy. In fact, till the early nineties Indians were used to ignore

inflation. But, since the mid-nineties controlling inflation has become a priority. The natural fallout of this

has been that we, as a nation, have become virtually intolerant to inflation. The opening up of the Indian

economy in the early 1990s had increased Indias industrial output and consequently has raised the India

Inflation Rate. While inflation was primarily caused by domestic factors (supply usually was unable to

meet demand, resulting in the classical definition of inflation of too much money chasing too few goods),

today the situation has changed significantly.

Inflation today is caused more by global rather than by domestic factors. Naturally, as the Indian economy

undergoes structural changes, the causes of domestic inflation too have undergone tectonic changes.

The main cause of rise in the rate of inflation rate in India is the pricing disparity of agricultural products

between the producer and consumers in the Indian market. Moreover, the sky-rocketing of prices of food

products, manufacturing products, and essential commodities have also catapulted the inflation rate in

India. Furthermore, the unstable international crude oil prices have worsened the situation.Defining causes of Inflation

What exactly is the nature of this inflation which has the nation in its grip? The different causes of inflation

which are experienced in Indian economy in a large proportion would be:-

Demand-pull inflation: This is basically when the aggregate demand in an economy exceeds the

aggregate supply. It is also defined as `too much money chasing too few goods. Bare -boned, it means

that a country is capable of producing only 100 items but the demand is for 105 items. Its a very simple

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demand-supply issue. The more demand there is, the costlier it becomes. Much the same as the way

real estate in the country is rising.

Cost-push inflation: This is caused when there is a supply shock. This represents the condition where,

even though there is no increase in Aggregate Demand, prices may still rise. I.e. non availability of a

commodity would lead to increase in prices. This may happen if the costs of especially wage cost rise.

Imported Inflation: This isinflation due to increases in the prices of imports. Increases in the prices of

imported final products directly affect any expenditure-based measure of inflation. They play an

important role in driving the rise in domestic prices. The rise in the global prices of crude oil and

agricultural commodities, including food grains, and industrial products, and setbacks to global economy

resulting from sub-prime mortgage disaster and US recession have contributed to Indias inflation.

Other Causes:

When the government of a country print money in excess, prices increase to keep up with the increase

in currency, leading to inflation.

Increase in production and labor costs, have a direct impact on the price of the final product, resulting in

inflation.

When countries borrow money, they have to cope with the interest burden. This interest burden results

in inflation.

High taxes on consumer products, can also lead to inflation. An increase in indirect taxes can also lead

to increased production costs.

Inflation can artificially be created through a circular increase in wage earners demands and then the

subsequent increase in producer costs which will drive up the prices of their goods and services. This

will then translate back into higher prices for the wage earners or consumers. As demands go higher

from each side, inflation will continue to rise.

Debt, war and other issues that cause a drastic financial blunder can also cause the inflation.

Measuring Inflation

Inflation in India is mainly estimated on the basis of fluctuations in the wholesale price index (WPI). The

wholesale price index comprises of the following indices:

Domestic Wholesale Price Index (DWPI)

Export Price Index (EPI)

Import Price Index (IPI)

Overall Wholesale Price Index (OWPI)

The WPI consists of about 435 items and has three broad categories. They are:-

Primary Articles (weight of 22.0253) 22% Index

Fuel, Power, Light, and Lubricants (weight of 14.2262) - 14% Index

Manufactured Products (weight of 63.7485) 64% Index

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The base year of the WPI is 1993-94. The base year usually chosen is one where there has been fairly

less volatility. The Indian WPI figure is released weekly on every Thursday. But recently the government

has approved the proposal to release a wholesale price based inflation data on a monthly basis, instead

of every week. The new series of WPI based inflation with 2004-05 as the base year would be launched

soon. The move is aimed at improving the accuracy of the inflation data.

The monthly release of WPI is a widely-followed international practice. And, it is expected to improve the

quality of data. Collection of price data of manufactured products will, accordingly, have a monthly

frequency consistent with the practice of release of WPI. The new series of WPI based inflation with

2004-05 as the base year would be launched soon. However, the government will continue to release a

weekly index for primary articles, and commodities in the fuel, power, light and lubricants groups. The

weekly index will facilitate monitoring of prices of agricultural commodities and petroleum products, which

are sensitive in nature.

Problems of Inflation

It has been reported that the manufacturing capacity in India is running around 95 per cent, which usually

means it is running at full capacity. Therefore, when the price of manufactured products is increasing, it

means that demand is usually higher than supply and that is a clear case of demand-pull inflation.On the primary goods front, which consists of fruits, vegetables, food-grains etc, it is not that straight-

forward. It has certainly been all over the news that the prices of fruits and vegetables are increasing and

a trip to the supermarket or local grocery shop will testify to that. Although it is a clear case of demand-

pull inflation, on the other, it is also a bit of a supply shock when one considers the fact that there is an

abnormally high percentage of fruits and vegetables that goes to waste because of the lack of cold-

storage facilities. Some estimates say 50 per cent of produce goes to waste and that is a conservative

number.

The fuel price hike is a straight example of cost push inflation. When OPEC (The Organization of the

Petroleum Exporting Countries) was formed, it squeezed the supply of oil and this caused oil prices to

rise, contributing to higher inflation. Since oil is used in every industry, a sharp rise in the price of oil leadsto an increase in the prices of all commodities.

The in depth problems due to inflation would be:

When the balance between supply and demand goes out of control, consumers could change their

buying habits, forcing manufacturers to cut down production.

Inflation can create major problems in the economy. Price increase can worsen the poverty affecting low

income household.

Inflation creates economic uncertainty and is a dampener to the investment climate slowing growth and

finally it reduce savings and thereby consumption.

The producers would not be able to control the cost of raw material and labor and hence the price of the

final product. This could result in less profit or in some extreme case no profit, forcing them out of

business.

Manufacturers would not have an incentive to invest in new equipment and new technology.

Uncertainty would force people to withdraw money from the bank and convert it into product with long

lasting value like gold, artifacts.

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The imbalances inflation has created in the Indian economy:-

It has created a new rich class in social and political lives who are corrupt themselves and also corrupt

the overall society.

The increased prices reduced the capacity to save and people preferred present consumption to future

consumption.

It has provided protection and subsides to industries which bred inefficiency.

It has lead to misallocation of resources due to distortion of relative prices and finally a redistribution of

wealth from the poor to the rich.

It disturbs balance of payments.

Curbing Inflation

There are several reasons why we should worry about the spike in the inflation rate. Inflation is a tax on

the poor and long-term lenders. Inflation is already too high, though it is definitely not at economy-

wrecking levels. But its best to be serious about the threat it poses. Inflation has emerged as the biggest

risk to the global outlook, having risen to very high levels across the world, levels that have not beengenerally seen for a couple of decades.

Currently, in India, we go through boom-and-bust cycles; sometimes GDP growth rates are very high and

sometimes GDP growth rates drop sharply. This boom-and-bust cycle is unpleasant for every household.

There is a powerful international consensus that stabilizing inflation reduces this boom-and-bust cycle of

GDP growth.

India is facing the problem of inflationary pressure because of the increase in Aggregate Demand while

Aggregate Supply is respectively constant. The inflationary pressure faced by Indian Economy is due to

Demand-Pull inflation i.e. Aggregate Demand > Aggregate Supply. Thus to curb inflation need to fill the

gap between Aggregate Demand and Aggregate Supply. For this either we need to increase Aggregate

Supply or decrease Aggregate Demand that can hamper economic development. To increase AggregateSupply either there is a need to increase production capacity of all current production units or to build new

production plants.

But as quoted in a survey done by RBI that all the production plants are running at their full production

capacity thus all resources are full employed. The other way is to build new plant but to do this will take at

least 18months to 2years. Thus meanwhile we need to decrease Money Supply, which is opted by RBI.

Increasing production of useful goods and services is what India should focus on.

As in the short run it is not possible to meet the gap between Aggregate Demand and Aggregate Supply

thus RBI is planning to decrease liquidity by reducing Money Supply from the market. RBI planned that

Liquidity from the market can be drained by decreasing money supply and to do so it is increasing CRR,

repo rate, reverse repo rate and taking other measure like that.CRR i.e. Cash Reserve Ratio (Liquidity Ratio) is the percentage of deposit that a commercial bank needs

to keep with RBI by which RBI control liquidity in the market and create Money Supply. Repo Rate is the

rate at which RBI lends money to other commercial Banks.

The Reserve Bank said that such decisions had been taken to curb inflation in India. RBI is taking positive

steps to reduce the inflation since inflations rates are going up week by week. By raising the reserve rate,

a deflationary pressure can be put on the economy, since the money multiplier has been reduced. People

will therefore save more. But in this hike, there is negative impact in terms of higher interest rates and

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personal loans, vehicle loans and other loans become costly. RBI may hike the rate to reduce the money

circulation in the country but it also decreased the sales of all loan items and further it reduces the

manufacturing activity of many industries. Now the public and private sector banks may raise the interest

rate at which they lend money to borrowers.

Produce more exports than imports than another country, then your money deflates with respect to that

currency. Exporting becomes a problem cause buyers from outside feel that the goods are expensive so

they prefer buying some other countrys goods with cheaper rate. Thus money does not come in. in the

same way, when public has more money they buy foreign goods, thus money goes out which is bad.

There is a need to encourage people to purchase goods produced within the country.

It is important for policymakers to make credible announcements and degrade interest rates. Private

agents must believe that these announcements will reflect actual future policy. If an announcement about

low-level inflation targets is made but not believed by private agents, wage-setting will anticipate high-

level inflation and so wages will be higher and inflation will rise. A high wage will increase a consumers

demand (demand pull inflation) and a firms costs (cost push inflation), so inflation rises. Hence, if a

policymakers announcements regarding monetary policy are not credible, policy will not have the desired

effect.Keynesians emphasize reducing demand in general, often through fiscal policy, using increased taxation

or reduced government spending to reduce demand as well as by using monetary policy. Supply-side

economists advocate fighting inflation by fixing the exchange rate between the currency and some

reference currency such as gold. This would be a return to the gold standard. All of these policies are

achieved in practice through a process of open market operations.

As individuals what can we do to stop Inflation?

Firstly save!!! As much of your money as possible should be saved. This will reduce the demand on the

economy and hopefully reduce inflation. Do not overuse daily essentials like cooking gas, electricity etc.

Cut down on inessentials when buying groceries. Look for cheaper alternatives to products that you

normally buy.Keep roads, highways, sidewalks, etc., beautified to help attract tourism and bring additional monetary

into a growing economy. Stop illegal immigration. Illegal activities reap the benefits of the country but

dont pay taxes. Government-backed investment schemes such as Post Office Savings Schemes, Public

Provident Funds (PPF) and National Savings Certificates (NSC) are best to invest in when inflation is

slowly inching up and you are only looking at safety, not returns. Invest in short term deposits and funds,

commodities and property. This will help you to slowly reach your financial goals while safeguarding your

hard-earned money.

http://www.mbaknol.com/managerial-economics/case-study-inflation-in-india/

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http://articles.cnn.com/2011-06-14/world/india.inflation_1_interest-rates-second-fastest-growing-

major-economy-inflation?_s=PM:WORLD

http://www.investorwords.com/2452/inflation.html

http://articles.cnn.com/2011-06-14/world/india.inflation_1_interest-rates-second-fastest-growing-major-economy-inflation?_s=PM:WORLDhttp://articles.cnn.com/2011-06-14/world/india.inflation_1_interest-rates-second-fastest-growing-major-economy-inflation?_s=PM:WORLDhttp://articles.cnn.com/2011-06-14/world/india.inflation_1_interest-rates-second-fastest-growing-major-economy-inflation?_s=PM:WORLDhttp://www.investorwords.com/2452/inflation.htmlhttp://www.investorwords.com/2452/inflation.htmlhttp://www.investorwords.com/2452/inflation.htmlhttp://articles.cnn.com/2011-06-14/world/india.inflation_1_interest-rates-second-fastest-growing-major-economy-inflation?_s=PM:WORLDhttp://articles.cnn.com/2011-06-14/world/india.inflation_1_interest-rates-second-fastest-growing-major-economy-inflation?_s=PM:WORLD

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