Subject: Economic & Social Development
Topic: Inflation : Concepts, Facts & Policy

Ques. 1 : Define Inflation.

Ans. 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 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 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. If it aggravates, galloping inflation can worsen to ‘runaway” inflation which may change into a hyperinflation. Hyperinflation is inflation that is “out of control,” a condition in which prices increase rapidly as a currency loses its value. No definition of hyperinflation is universally accepted. One simple definition requires a monthly inflation rate of 20 or 30% or more ‘an inflationary cycle without any tendency toward equilibrium’. The worst is a monetary collapse, if prices are not reined in, in time.

Other related concepts are

• deflation when there is a general fall in the level of prices
• disinflation which is the reduction of the rate of inflation
• stagflation which is a combination of inflation and rising unemployment due to recession and
• reflation, which is an attempt to raise prices to counteract deflationary pressures.

Ques. 2 : Describe the measures of inflation.

Ans.

CDP 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.