Inflation – Meaning and Types – Deflation – Stagflation

Inflation: Meaning  

Inflation is a serious problem faced by many economies of the modern world.

In simple language inflation can be defined as a situation in which the prices rise steadily, significantly, generally and cumulatively. According to most economists inflation can be said to have taken place only when the prices keep on rising at the rate of more than five percent per year for a sustained period. Demand pull inflation: This inflation is the most common form of inflation. It is also known as the traditional theory of inflation. According to Keynes inflation takes place when the aggregate demand exceeds aggregate supply. In other words when demand for goods and services is more than their supply, their prices rise. This is known as demand pull inflation. Generally this type of inflation takes place when too much money chases a too few goods. Thus, it is the result of increase in money expenditure on goods and services.

Cost-push inflation: This is known as Modern theory of inflation. When the prices of goods and services increase due to increase in their cost of production, it is known as cost-push inflation.

For example, if the prices of factors of production employed in the steel industry increase, the cost of production of steel will increase, the cost of transport vehicles and tractors in whose production the steel is used will go up and ultimately the transportation charges will go up, the prices of consumer goods will increase, the wages of workers will have to be increased and so again there would be pressure on the prices

When the cost of living increases, due to increase in the general price level, the factors demand higher wages etc and so the cost of production increases and there is a further increase in prices. This is known as cost push inflation. Thus, increase in prices brings about increase in cost and increase in cost brings about increase in prices. This is known as inflation spiral. When wages and prices both support each other it is known as wage price spiral.

Types of Inflation.

1. Deflation:

This means continuously falling prices. It is opposite of inflation.

It has the following effects

1. Consumers gain as the real purchasing power of their money holdings increases.

2. The profits are continuously falling. This leads to decrease in investment.

3. National Income, employment and output fall

It leads to gloom, pessimism, recession and ultimately to depression leading to wide spread poverty and misery


2. Stagflation:

Stagflation is a combined phenomenon of demand pull and cost push inflation.

This is situation where there is a co-existence of rising prices and a significant unemployment. In other words, it is a combination of stagnancy and inflation. In this situation, the prices and wages both are rising. Thus there is a mixture of demand pull and cost push factors. The increase in wages brings about increase in demand as well as in cost of production giving rise to a simultaneous situation of demand pull and cost push inflation.

India experienced this situation during the period 1991 to 1994. During this period on one hand prices went up rapidly due to large budget deficits, the increase in the oil prices due to Gulf war, increase in wages, increase in bank credit and rapidly rising public expenditure and on the other hand the Supply did not increase due to low rates of growth, slow industrial development etc. Thus while on one hand the economy was stagnating on the other hand prices were rising Inflation in India:

In India, the variation in prices are measured in terms of Wholesale Price Index (WPI). They can also be measured in terms of Consumer Price Index (CPI).

Wholesale Price Index (WPI): The Wholesale Price Index (WPI) is the price index of a representative basket of wholesale goods. The WPI focuses on the price of goods in the wholesale market. This basket comprises 676 items which carry different weights WPI measures headline inflation ie it includes the entire set of commodities. This is different from core inflation in which the commodities which have volatile prices (like food and fuel)are not considered Also WPI does not include services and non-tradable commodities. Currently, in India WP series with base 2004-05 is being used to assess price changes.

Consumer Price Index (CPI): A consumer price index (CPI) measures changes in the price level of consumer goods and services purchased by households. It reflects the cost of living for a homogeneous group of consumers. There are 4 CPI indices in India. These are CPI for industral workers CPL for agricultural labour, CPI for rural labour and CPI for urban non-manual employees

Since CPI measures changes in the price level of goods purchased by the ultimate consumers, it shows the real inflationary pressure on consumers and is, thus a more realistic measure than WPI. In 2013-14 the average of WTT was 5.98%, the average of CPI for industrial workers was ok. This was mainly due to food inflation in India. Thus, there are significance variation in the inflation rates given by WPI and CPI

However, in India the mam focus is on WPI. Moreover, there is no single CPI but four CPIs an stated above.

The Central Statistics Office (CSO) has come out with a new series on CPI with base 2010-100, (on 12th Feb 2015 the base year for CPI has been changed to 2012).

This series intends to reflect the actual movement of prices at the micro-level. According to new series, Consumer Price Index has remained at around 9 to 10% and headline inflation at 6% in 2013-14

Trends of prices in India: The following table gives an idea regarding the price trends in India. (The data show annual average increase in prices if they do not relate to individual years.)

A. During the 50’s the average rate of inflation was 1.7% per year. (Modest or moderate inflation)

B. During 60’s average rate of inflation was 6.4%. The maximum rate of inflation 13.9% was recorded in the year 1966-67. The main reasons for the price increase were China war in 1962 and Pakistan wars in 1965 and due to wide spread famine in agriculural sector.
C .Daring the 70’s it was 9%

D. During the 80’s it was 8%

E. During the first half of 90’s it was around 10%

F. During the years 1990 and 1991, the inflation rate was 12%. This was mainly due to gulf crisis and resultant increase in old prices.

G. The growth in prices both at the wholesale level and retail level has been particularly love between the period 1996-97 to 2003-04 It has been around 5 per cent per annum during 1996-2001 and around 4 per cent per annum during 2001-04

H . Itaveraged around 65 per cent during the year 2004-05. Crude oil prices continued rising during 2005-06 but due to monetary and fiscal measures taken by the government the inflation was contained at 47 per cent during 2005-06

I. In 2006-47 the prices have continued rising due to short fall in domestic production of food grains as against the demand, and hardening of international food prices during the period.

J. The long term inflation for the period 2000-10 was 3.3% per annum.

* The year 2008-09 recorded the highest rate of inflation of the decade with the growth of 5.4% in the wholesale price index. (WPI) However in 2009-10 the inflation rate was 3.8%

L . During 2010-11 the average inflation was 9.6%, the highest in the last 10 years.

M. In 2011-12 it was 91% This price increase was due to food inflation, that is higher prices of vegetables, eggs, meat, fish etc, and increasing commodity and food of prices in the international markets.

N. In 2013-14 it was between 9 to 10% Factors Responsible for Price

Increase: A number of factors both on the demand as well as the supply side have contributed to the problem of inflation. These are as under

A Demand side Factors:

1. Rising Plan expenditure: One of the reasons is the rising plan expenditure. The targeted Investment in the First five year plan was 1960 crores and in the 11″ plan it was? 3644.718 crores. This investment has increased incomes of people and therefore the demand for goods and services and so their prices.

2. Deficit Financing: Price increase is generally due to increase in money supply and the increase in money supply is due to the policy of deficit financing This kind of policy on the part of the Govt. has contributed a great deal in bringing about an increase i prices. This is because the deficit financing makes the government to put purch power in the hands of public but it does nothing to increase the real output in the economy.

3. Increase in non-developmental expenditure: Public expenditure has risen from 1k6y of GDP in 1961 to around 28% in 2012-13 (Current prices)

If public expenditure is productive, it brings about an increase in the supply of gods and services and thereby helps in controlling the price level. However in the reces years there has been a significant increase in the unproductive expenditure of the C in the form of interest payment, subsidies, defence, expenditure on civil administra etc. This kind of expenditure increases demand but not supply of real goods. Sea pressure of demand is created on the existing supply. This kind of pressure on demand leads to price increase

B. Supply Side Factors:

These factors are as follows

1. Erratic agriculture growth: In India the agriculture is largely dependent on monsoon The agriculture production has been fluctuating When crops fall the agricultural prices go up and the general price level is also affected.

2. Inadequate Industrial Production: During the period 1965-85 the industrial production increased in the rate for 4.7%. Similarly 1991 onwards the industrial production has increased at the rate of average 6% During 2012-14 the growth rate of industial production was less than 1%. On the other hand the demand for the industrial consumer goods such as textiles, footwear, food products, etc. has been much greater than the supply due to increasing money incomes of people

3. Agricultural price policy of the Government The government has continuously increased the procurement and support prices of food articles to please the farmer lobby. While this has benefitted the farmers, the general price level has gone up

4. Administered prices or Govt’s Price policy: Administered prices are determined by the government. The prices of things like petrol, diesel, gas, kerosene, telephones electricity, railway services etc. are fixed by the government. The public sector unit India make losses. To cover them, the Govt has continuously increased the prices d the goods and services produced by them. This has significantly added to cost push inflation in India

Other factors:

A severe increase in the prices of imported articles like food, fertilizers and fuel The Government’s failure to increase taxes in the proportion of rising money incomes of people leaving a large purchasing power with the public.

Large scale tax avoidance and tax evasion resulting into a high luxurious consumption Shortage of essential rave-materials

Infrastructural bottlenecks Black marketing and hoarding of essential commodities Low surplus of public sector enterprises Unised production capacities High capital output ratio Anti-inflationary policy or Inflation control policy of the government of India. Introduction: The problem of rising prices has been one of the major problems in India. The prices started rising in India, the second five year plan onwards The Government takes following measures to control inflation

A. Demand Management:

1. Monetary Measures: Monetary measures are taken by the government through the Central Bank. They are the measures related to credit control. Here, the central bank may raise the bank rate it also raises CRR and SLR. it sells Government securities in the open market. it takes various other measures such as penal interest rates, changes in margin requirements, credit rationing, and other measures of direct credit control

2 Fiscal Measures: Fiscal measures are implemented by the govt through its budgetary operations Here. the government raises the rates of direct as well as indirect taxes controls unproductive public expenditure mobilises the purchasing power with the public through public loans introduces new taxes. For example, service tax takes measures for improving the profits of public sector units. avoids deficit financing

3. Control on investment: The Government reduces investment which gives returns only in the long run and encourages investment which brings about an immediate increase In output

B. Supply Management or other measures:

The Government has created public distribution system having more than 45000 fair price shops to provide essential goods to the poor at subsidized prices Frequently imports of food, edible oils, etc. have been undertaken.

The Government has occasionally introduced rationing of goods during the tim of extreme shortages

As a long term measure the government has emphasised accelerating the tempo economic development and increasing the production of wage goods.

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