Inflation & Deflation
16.1 Inflation
“Inflation is a state of economy where value of money is declining and
the prices are increasing.” Under inflation, general price level increases
above normal price level.
Debtor gains in inflation
because he has to pay lower amount in terms of money value under inflationary
condition. Under inflation, money value reduces. Saver, creditor, pension
holder are badly effected under inflation. [Q:55]
Increase in GDP, rise in
employment level, increase in the real income bring inflation. Because these
things increase the money supply in market, brings more demand.
Inflation Status in India
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The maximum inflation at 13.9 was recorded for the year 1966-67
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As per April 2007, Inflation rate was 6.3%.
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Consumer price index is used for
measurement of inflation.
Types of inflation
i. Demand-Pull Inflation: In a market there is
interaction between the flow of money and flow of goods and services. When more
money chases relatively less quantity of goods and services the excess of demand
relative to supply pushes up the prices of goods and services. Such inflation,
as a result of increased money expenditure, is called demand-pull inflation.
ii. Cost-push Inflation: It is caused by a rise in
the cost of factors of production. In fact, demand-pull inflation is responsible
for cost-push inflation, because, when the demand-pull inflation sets in, there
is a rising demand for the factors of production, which increase their prices.
The cost-pull inflation may also cause due to rise in the wages or due to rise
in profit margin.
iii. Stagflation: It is the combined effect of
‘Demand pull inflation’ and ‘Cost pull inflation’. Stagflation = Stagnation +
Inflation. In this case, there is low
rate of growth, which results in economic stagnation. On the other hand, the
general price level continuously rises.
In developed countries, the
growth rate may be low, because their industries have already matured. But
their strong labour unions may force to enhance the wage rate continuously,
which results into stagflation.
v. Suppressed inflation: When the government imposes physical and monetary
controls to check open inflation, it is known as suppressed inflation.
vi. Galloping inflation : If Mild inflation is not controlled and it is
allowed to go on, it is called galloping inflation.
vii. Hyper inflation. : If price line goes to a uncontrollable stage, it is called hyper
inflation. [Q:38]
Effects of Inflation
Inflation causes a number
of problems in our economy. Some of its adverse effect are:
i. Adverse effect on
production: Due to the economic recession caused by inflation in many sectors of the
Indian economy, the prices of important articles of consumption rise causing
fall in demand. In line with fall in demand, production too reduces.
ii. Adverse effect on
distribution of income: The producers, traders and speculators always gain
enormously through ever-rising profit margins and through illegal gains and
windfall profits, due to hoardings, speculation and black marketing. The people
living on past savings, fixed interest and rental income and old-age pensioners
become victim of depreciation in the buying power of the rupee.
iii. Resistance to development: Due to price rise,
government expenditure plans based on earlier price levels cannot the target.
Consequently, economic development suffers.
16.2 Causes of Inflation in India
Some of significant causes
of inflation in India
i. Excessive population growth: Fast increase in the population brings inflation in
the country. When the population of a country increase rapidly, but the supply
of the goods do not increase in the same proportion, then it raises the general
price level. Due to explosive population growth, there will be scarcity of
essential goods. Demand will exceed the supply level. Consequently, price level of essential goods will increase causing
inflation. India India
ii. Increase in public expenditure: Increase in public expenditure increases the
purchasing power of the people. If public expenditure rises without
simultaneous increase in supply of goods, this will promote inflation in the
country. In recent year, government has increased its public expenditure in its
budget for country’s development. Increase in public expenditure is also the
reason behind recent inflationary economic condition.
iii. Irregular agricultural growth: Most of the industries of our country depend on
agricultural (e.g. cotton, jute, sugarcane, tea, tobacco, etc.). The failure of
crop leads to failure of industries to produce the common goods. So, failure of
agricultural due to drought etc. increases not only the price of food article
but also the general price level. So, agricultural failure brings inflation to
Indian economy.
iv. Deficit financing: When the government spends more than what it expects to collect as
revenue; it takes the help of deficit financing. Under the deficit financing,
the government issues more currency in the market or borrows the funds from
foreign governments or international agencies. It results in more money in the
market and increases the price level.
v. Imposition of high rate of indirect tax: Another source of
inflation is higher taxes, especially indirect tax like sales tax, excise etc.
imposed by the government. Such taxes increases the selling price of the
commodities. Thus higher indirect taxes increase the commodity prices in the
market. Indirect taxes are great source of revenue to the government. Government
often resorts to higher indirect taxes to meet its expenditure.
16.4 Measures for controlling inflation
Inflation is a situation,
which takes place either due to a increase in the buying power of the people or
due to the excessive money in circulation. Therefore, it can be regulated
either by regulating the purchasing power of the people or by decreasing the
money in circulation.
Measures to regulate the inflation
a. Monetary Measure: Monetary measures are taken by the central bank of the country (such as
RBI in India
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Bank rate
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Open market operations
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Cash Reserve Ratio
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SLR
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Credit ceiling
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variable margin requirement
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Variable interest rate
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regulation of consumer credit
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Moral suasion
If RBI increases bank rate,
commercial Bank’s credit creation capacity reduces By reducing the bank credit
in the market. Government decreases the supply of money in the market. Change
in Cash Reserve Ratio (CRR) also reduces the credit creation capacity of
commercial banks. Open market operations is also another measure to reduce the
money in circulation. These measures reduce the money supply in the market.
b. Fiscal Measure: Fiscal measures are also very effective for controlling the inflationary
economic conditions. Fiscal measures
are a part of the budgetary operations of a government.
Following measures are
normally taken for controlling the
inflation situation.
i.
Anti inflation taxation
policy: The
government, as an anti-inflationary measure, may increase the rate of existing
taxes and impose new taxes on the commodities and services, so as to leave
lesser money with the public to purchase goods and services. Increase in direct
tax rate also decreases the money supply.
ii.
Public Borrowings: Public borrowing is also
another measure to decrease inflation. Under this measure, the government
borrows the money from public. The main object of public borrowings is to take
away the public from excessive purchasing power. Thus, during the period of
inflation, the government should increase the public borrowings to reduce the
purchasing power of the public. Public borrowings reduces the money supply in
the market.
c. Other Measure:
i.
Wage Policy: Restrictive wages policy
should be taken to reduce the inflationary pressure in the economy. The
wage-increase should be linked with the increase in productivity. If this
criterion is followed, higher prices will not increase the unit cost and unit
price. Under inflationary condition, high wages rate increases the inflation.
ii.
Price Control &
Rationing: It
is a direct method to control price level. The main aim of price control is to
determine the maximum limit beyond which the price of a particular commodity
not be allowed to rise. Generally, when inflation goes to a such an extent that
monetary measures and fiscal measures cannot effectively control the inflation,
government uses restrictive pricing policy by fixing maximum price for a
particular commodity. Government adopts these measures for controlling
inflation in public interest because in
case of inflation poor people are badly affected due to inflation.
16.5 Deflation
Deflation is a state in
which the prices are falling and thus the value of money is increasing.
Deflation is just the opposite of inflation.
Effects of Deflation
During deflation, there is
a fall in the national income of the economy and there is a large scale
unemployment in the economy. Massive unemployment and all around gloom pervade
the economy. The government, generally, has to take initiative by increasing
public expenditure and other investment expenditure to increase employment
level and to take the economy out of deflationary situation.
Inflation Vs. Deflation
Inflation disturbs of
income between different groups of people in an in-equitable manner; the rich
gain at the expenses of the poor. Deflation, on the other hand, reduces
national income through a fall in production on account of unemployment. It
renders the whole country poor including the petty wage-earners who may suffer
due to unemployment.
Inflation demoralizes people, it encourages
speculative hoarding and profiteering. Deflation also has a social cost because
of unemployment of the people.
Both are thus evils but deflation is considered to be
the bigger evil probably because inflation is easier to control than deflation.
Also, deflation inflicts greater injury on the economy, the effect of which is
long lasting, Economic stabilization with full or near full employment is,
therefore, the ideal which a country should try to achieve.
In regard to government expenditure, it should be
restricted during the period of inflation. But, normally, governments fail to
keep a check on expenditure, can be stepped up. This will help employment by a
revival of demand of goods.
Public debt should be so managed that supply of money
in the country is controlled. During inflation, government should not pay back
the past loans. They can be renewed. Further, it should, through surplus
budgets, cancel the debts which it owes to the bank.
