(IGP) GS Paper 1 - Economic & Social Development - "Inflation - Concepts, Facts & Policy"

Subject - Economic and Social Development
Chapter - Inflation - Concepts, Facts & Policy

Inflation:

• Inflation means a persistent rise in the price of goods and services. Inflation reduces the purchasing power of money. It hurts the poor more as a greater proportion of their incomes are needed to pay for their consumption. Inflation reduces savings; pushes up interest rates; dampens investment; leads to depreciation of currency thus making imports costlier.

Depending upon the rate of growth of prices, inflation can be of the following types:

Creeping inflation

• Creeping inflation is a rate of general price increase of I to 5 percent a year. Creeping inflation of 3 to 5 percent erodes the purchasing power of money when continued over many years, but it is “manageable.” Furthermore, a low creeping inflation could be good for the economy as producers and traders make reasonable profits encouraging them to invest.

Trotting inflation

• Trotting inflation is usually defined as a 5 to 10 percent annual rate of increase in the general level of prices that, if not controlled, might accelerate into a galloping inflation of 10 to 20 percent a year.

Hyperinflation

• Hyperinflation is inflation that is “out of control,” a condition in which prices increase rapidly as a currency loses its value.

Measures of Inflation:

GDP deflator

• GDP stands for gross domestic product, the total value of all final goods and services produced within that economy during a specified period.
• GDP deflator is a measure of the change in prices of all new, domestically produced, final goods and services in an economy.
• The GDP deflator is not based on a fixed market basket of goods and services but applies to all goods and services domestically produced.

Cost of living index

• The cost of living is the cost of maintaining a certain standard of living. It is defined with reference to a basket of goods and services. When their cost goes up, CoL is said to be dearer and the index will go up. It has a value of 100 in the base year. An index value of 105 indicates that the cost of living is five percent higher than in the base year.

PPI

• Producer price index (PPIs) measures the change in the prices received by a producer. The difference with the WPI is accounted for by logistics, profits and taxes, mainly, Producer price inflation measures the price pressure due to increase in the costs of raw materials. It may be absorbed by them or made up by increases in productivity or passed on to the consumers. It depends on the market conditions.

WPI

• Wholesale price indices, which measure the change in price of a selection of goods at wholesale, prior to retail sales thus excluding sales taxes. These are very similar to the Producer Price Indexes.

CPI

• Consumer price index measures the changes in prices paid by the consumer at the retail level. It can be for the whole community or group-specific for example, CPI for industrial workers etc as in India.

Types of Inflation

• Demand- pull inflation: inflation caused by increases in demand due to increased private and government spending, etc. It involves inflation rising as real gross domestic product rises and unemployment falls. This is commonly described as ‘too much money chasing too few goods’.
• Cost- push inflation: It is also referred to as “supply shock inflation,” caused by reduced supplies due to increased prices of inputs, for example, crude prices globally have gone up causing supply constraints which means higher costs of production and so higher prices.
• Structural inflation: A type of persistent inflation caused by deficiencies in certain conditions in the economy such as a backward agricultural sector that is unable to respond to people’s increased demand for food, inefficient distribution and storage facilities leading to artificial shortages of goods, and production of some goods controlled by some people.

To Control Inflation

• There are fiscal, monetary, supply-side and administrative measures to control inflation to ideal/optimal rates though zero rate of inflation is never preferred for the reasons cited elsewhere in the lesson.

• Fiscal measures include reduction in indirect taxes
• Dual pricing like in sugar.
• Monetary measures include rate and reserve requirements changes. Open market operations can stabilize prices under normal conditions Also, sterilization through Government bond transactions as in the case of MSBs.
• Supply side factors include making goods available- import of wheat in India.
• Administrative measures include implementation of dehoarding and anti-black-marketing measures. Wage and price controls can also be used

Inflation Targeting:

• Inflation targeting focuses mainly on achieving price stability as the ultimate objective of monetary policy. This approach entails the announcement of an inflation target- either a number or a range, that the central bank promises to achieve over a given time period. The targeted inflation rate will be set jointly by the RBI and the government, although the responsibility of achieving the target would rest primarily on the RBI. This would reflect an active government participation in achieving the goal of price stability with fiscal discipline by way of a rational borrowing programme (not borrowing in excess).

Deflation

• Deflation is a prolonged and widespread decline in prices that causes consumers and businesses to curb spending as they wait for prices to fall further. It is the opposite of inflation, when prices rise, and should not be confused with disinflation, which merely describes a slowdown in the rate of inflation.
• Deflation occurs when an economy’s annual headline inflation indicator -- typically the consumer price index -- enters negative territory:
• Deflation is hard to deal with because it is self-reinforcing. Put simply, unless it is stopped early, deflation can breed deflation, leading to what is known as a deflationary spiral.

Remedy

• Tax cuts to boost demand from consumers and businesses
• Lowering central bank interest rates to encourage economic activity
• Printing more currency to boost money supply
• Capital injections into the banking system
• Increase government spending on projects that boost the return on private investment

Government’s Steps to Control Inflation

• The Government has taken a number of short term and medium term measures to improve domestic availability of essential commodities and moderate inflation.
• It has procured record food grains. Even after keeping the minimum buffer stock, there are enough food grains to intervene in the market to keep the prices at reasonable level.
• A Strategic Reserve of 5 million tonnes of wheat and rice has also been created to offload n the open market when prices are high. This is in addition to the buffer stock held, by FCI every year.
• Issue price of grains supplied through PDS outlets are frozen.
• The price situation is reviewed periodically at high-level meetings such as the Cabinet Committee on Prices (CCP).

New Price Index for Urban, Rural Consumers

• The Central Statistics Office (CSO), Ministry of Statistics and Programme Implementation has introduced a new series of Consumer Price Indices (CPI) on base 2010=100 for all-India and States/UTs separately for rural, urban and combined with effect from January, 2011.

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