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INFLATION AND DEFLATION :INFLATION AND DEFLATION DR. CHANDAN BORA (BORAs INSTITUTE OF

COMMERCE AND MANAGEMENT)

INFLATION :INFLATION

Introduction :Introduction Situation of Substantial and Rapid general increase in price level Decline in the value of

money Wholesale Price Index (WPI) or Cost of Living Index or Consumer Price Index (CPI) used for the

Definitions :Definitions According to the Crowthers Inflation means a state in which the value of money is falling i.e.,

prices are rising According to Pigou, Inflation arises when money income is expanding more than in proportionate to

income earning activity According to Prof. Samuelson Inflation occurs when the general level of prices and cost are

rising

Types of Inflation :Types of Inflation According to the Rate of Inflation 1. Creeping Inflation 2. Walking Inflation 3.

Running Inflation 4. Galloping Inflation 5. Hyper Inflation

Types of Inflation :Types of Inflation According to the Government Reaction 1. Open Inflation 2. Suppressed

inflation According to the Nature of Time Period of Occurrence 1. War Time Inflation 2. Post War Inflation 3. Peace

Time Inflation

Types of Inflation :Types of Inflation According to the Scope or Coverage 1. Comprehensive Inflation 2. Sporadic

Inflation According to the Nature 1. Full Inflation 2. Partial Inflatio

Types of Inflation :Types of Inflation According to the Causes 1. Credit Inflation 2. Currency Inflation 3. Scarcity

Inflation 4. Deficit Inflation 5. Profit Inflation 6. Tax Inflation 7. Cost Inflation 8. Demand

Causes of Inflation :Causes of Inflation Increase in money supply Expansion of bank credit Deficit Financing Black

Money Scarcity Taxes Increase in the supply of Gold Population Growth Entrepreneurial Bott

Effect of Inflation :Effect of Inflation Debtors and Creditors People with fixed income Consumers Producers and

Businessmen Agriculturists (Farmers) Tax Payers and Government

Inflation Vs. Deflation :Inflation Vs. Deflation

Inflation Vs. Deflation :Inflation Vs. Deflation

introduction :introduction Inflation


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Inflation :Inflation This is the process by which the price level rises and money loses value. There are two kinds of

inflation: a) Demand pull b) Cost push

Demand pull inflation :Demand pull inflation Demand pull inflation may be due to : Increase in money supply

Increase in government purchases Increase in exports

Cost push Inflation :Cost push Inflation Cost push inflation may arise because of : Increase in money wage rates

Increase in money prices of raw materials.

Hyper inflation :Hyper inflation Extremely rapid or out of control inflation. There is no precise numerical definition to

hyperinflation. Price increases are so out of control that the concept of inflation is meaningless. The most famous

example of hyperinflation occurred in Germany between January 1922 and November 1923. By some estimates, the

average price level increased by a factor of 20 billion!

Money and Prices During Hyperinflations :Money and Prices During Hyperinflations Copyright 2004 South-

Western (a) Austria (b) Hungary Money supply Price level Index (Jan. 1921 = 100) Index (July 1921 = 100) Price

level 100,000 10,000 1,000 100 1925 1924 1923 1922 1921 Money supply 100,000 10,000 1,000 100 1925 1924

1923 1922 1921

Stagflation :Stagflation A condition of slow economic growth and relatively high unemployment accompanied by

inflation. This happened to a great extent during the 1970s, when world oil prices rose dramatically, fueling sharp

inflation in developed countries. At least some central banks have expressed concern over inflation even as theglobal economy seems to be slowing down.

Money Supply, Money Demand, and the Equilibrium Price Level :Money Supply, Money Demand, and the

Equilibrium Price Level Copyright 2004 South-Western Quantity of Money Value of Money, 1 / P Price Level, P 0 1

(Low) (High) (High) (Low) 1 / 2 1 / 4 3 / 4 1 1.33

The Effects of Excess Money Supply :The Effects of Excess Money Supply Copyright 2004 South-Western

Quantity of Money Value of Money, 1 / P Price Level, P 0 1 (Low) (High) (High) (Low) 1 / 2 1 / 4 3 / 4 1 1.33 2 4

How is inflation measured? :How is inflation measured? WPI (Wholesale Price Index) India- the only major country

that uses WPI (1st published in 1902) What is WPI? The WPI number is a weekly measure of wholesale price

movement for the economy

WPI- The Indian Example :WPI- The Indian Example Indian government constructed its present WPI way back in

1993-94 (1993-94 series replacing 1981-82 bases) by making a basket of 435 commodities Laspeyres formula


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employed The 100-point index is subdivided into three groups

Slide 12:Major Groups: I. Primary Articles (98 items)- 22.02 % Food Articles, Non-Food Articles, Minerals II. Fuel,

Power, Light & Lubricants (19 items) - 14.23 % III. Manufactured Products (318 items) - 63.75 % Food Products

Beverages, Tobacco & Tobacco Products Textiles etc

Slide 13:The Office of the Economic Advisor (OEA) compile the WPI numbers on weekly basis On Friday inflation

figures are announced The working group on WPI, headed by Planning Commission member Abhijit Sen, has worked

out a new index The base year of the new index :2000-01 The basket of commodities- around 1200 To Reflect the

post-liberalisation consumption pattern

Consumer Price Index (CPI) :Consumer Price Index (CPI) A measure of the average price of consumer goods and

services purchased by households (1st published in 1970) CPI indicates the change in the purchasing power of the

consumer CPI for Industrial Workers (CPI-IW), CPI for Agricultural Labourers / Rural Labourers (CPI -AL/RL), CPI for

Urban Non-Manual Employees (CPI-UNME) Published on a monthly basis

Slide 15:Producer Price Index (PPI) Measures average changes in prices received by domestic producers for their

output Service Price Index (SPI) The share of the service sector in the (GDP) gone up from 28% (1950) to over 50%

Necessitates representation of Services in the price index

Discussion question :Discussion question Why is inflation bad?

Slide 17:Unanticipated inflation is bad because it makes the economy behave like a giant casino. Gains and lossesoccur because of unpredictable changes in the value of money. If the value of money varies unpredictably over time,

the quantity of goods and services that money will buy will also fluctuate unpredictably. Resources are also diverted

from productive activities to forecasting inflation. Unanticipated inflation leads to : Redistribution of income, borrowers

and lenders Too much or too little lending or borrowing

The Economic Impacts of Inflation :The Economic Impacts of Inflation Redistribution of Income and wealth among

different groups Distortion in relative prices and outputs of different goods, or sometimes in output and employment

for the economy as a whole.

THE COSTS OF INFLATION :THE COSTS OF INFLATION Shoe leather costs Menu costs Tax distortions Confusion

and inconvenience Arbitrary redistribution of wealth

Shoe leather costs :Shoe leather costs Shoe leather costs are the resources wasted when inflation encourages

people to reduce their money holdings. Inflation reduces the real value of money, so people have an incentive to

minimize their cash holdings. Less cash requires more frequent trips to the bank to withdraw money from interest-

bearing accounts.


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Menu costs :Menu costs Menu costs are the costs of adjusting prices. During inflationary times, it is necessary to

update price lists and other posted prices. This is a resource-consuming process that takes away from other

productive activities.

Inflation-Induced Tax Distortion :Inflation-Induced Tax Distortion The income tax treats the nominal interest earned

on savings as income, even though part of the nominal interest rate merely compensates for inflation. The after-tax

real interest rate falls, making saving less attractive.

Taming Inflation :Taming Inflation Monetary policy- Bank rate policies, Open Market operations, Reserve

requirement ratios Fiscal policy-taxation, public borrowing, public expenditure Direct Control-Fixing ceiling prices of

the products, Rationing. Miscellaneous methods-Controlling Wages, Controlling population growth

The Effects of Monetary Injection :The Effects of Monetary Injection Copyright 2004 South-Western Quantity of

Money Value of Money, 1 / P Price Level, P 0 1 (Low) (High) (High) (Low) 1 / 2 1 / 4 3 / 4 1 1.33 2 4

After nearly three decades, India is experiencing deflation once again. While inflation is a measure

signifying an increase in prices, deflation is just the opposite and indicates a contraction in demand or

goods and services and hence a fall in prices. In inflation, the value of your money goes down. It thus

follows that in deflationary mode the value of any currency

increases.

So while people should, in general, be happy about the value of each Rupee going up, the situation is

fraught with problems. For one, deflation is historically associated with periods of economic slowdown or

depression. Second, when the economy is experiencing negative inflation there is always the expectation

that prices will fall further and so consumers prefer to postpone purchases leading to a further fall in

aggregate demand of goods and services, which hits industry in a way that creates idle capacity and in

turn leads to losses and job cuts, which further enhances the negative sentiment and we find ourselves in

a situation called deflationary spiral.

In addition there is a fear that the economy may fall into a liquidity trap. What happens in this case is that

the government tries to stimulate the economy by initiating interest

rate cuts. However if this fails to spur the economy to a full employment point, the Central government

keeps pushing down rates till it reaches point zero. After this the government cant do anything and so

you have a situation where your saving orsecuritiesare not earning any interest on them but the

increased money supply fails to create additional demand. The successive rate cuts also work inversely in

a way that it prevents the government from stabilizing its monetary policy.

The reduction ofinterest rates has different effects in closed and open economies. In a country that is

heavily controlled by the government, the interest rate cuts dont necessarily have a huge stimulating

impact. Reason being that on zero interest rates, returns on government securities are also nil and can
http://www.zeenews.com/news543933.htmlhttp://www.zeenews.com/news543933.htmlhttp://www.zeenews.com/news543933.htmlhttp://www.zeenews.com/news543933.htmlhttp://www.zeenews.com/news543933.htmlhttp://www.zeenews.com/news543933.htmlhttp://www.zeenews.com/news543933.htmlhttp://www.zeenews.com/news543933.html


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even be in the negative on short term investments. On the other hand, in economies that face less

interference from the government, the effect could be of carry trade(where investors borrow cheaper

currencies and lend more valuable ones) and devalues currency which makes imports more expensive

without necessarily increasing the volume of exports.

There is also a perceived positive side to deflation. It improves the value of money in a way that benefits

common man and especially the poor by brining essential commoditieslike food, clothing etc within their

reach more easily. This improves their standarIndias 2008 Economic Survey Report targeted a drop

in Indias Inflation Rate but with food, oil and commodity price rises worldwide, the opposite is

happening.

According to the 2008 Economic Survey Report, Indias inflation rate was targeted by the Reserve Bank of

India (RBI) to be 4.1%, down from a rate of 5.77% in 2007. Inflation rates for many investment goods have

decreased dramatically in recent years. The price of basic goods such as lentils, vegetables, fruits and

poultry were expected to slow their rise. The price of various manufactured goods also fell in 2007, and this

contributed to a reduced inflation rate

However, the beginning of 2008 has seen a dramatic rise in the price of rice and other basic food stuffs.There has also been a no-less alarming rise in the price of oil and gas. When coupled with rises in the priceof the majority of commodities, higher inflation was the only likely outcome.

Indeed, by July 2008, the key Indian Inflation Rate, the Wholesale Price Index, has risen above11%, its highest rate in 13 years. This is more than 6% higher than a year earlier and almostthree times the RBIs target of 4.1%.

Inflation has climbed steadily during the year, reaching 8.75% at the end of May. There was an alarmingincrease in June, when the figure jumped to 11%. This was driven in part by a reduction in government fuelsubsidies, which have lifted gasoline prices by an average 10%.

The Indian method for calculating inflation, the Wholesale Price Index, is different to the rest of world. Eachweek, the wholesale price of a set of 435 goods is calculated by the Indian Government. Since these arewholesale prices, the actual prices paid by consumers are far higher.

In times of rising inflation this also means that 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. d of living despite the economy being in recession
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