Inflation - Group 1

7/27/2019 Inflation - Group 1

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INFLATION

A PRESENTATION BY

GROUP 1

Piyush Malhotra 135Ishan Adlakha

136

Anand Kumar

137Anu Lall 138

Russel Nayyar

139

Kanika Monga 140


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FLOW OF PRESENTATION

What is Inflation? Effects of Inflation

Types of Inflation

Inflation In IndiaCost Push Demand Pull

Philips Curve

WPI & CPIMeasures To Control Inflation

Impact of Inflation


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WHAT IS INFLATION?

Inflation is the rate at which the general level of pricesfor goods and services is rising and subsequently thepurchasing power is falling.

It is a situation where the aggregate demand ofgoods and services exceeds the available supply anddue to this there is increase in price level which issustained in a economy for a period of time.

Whenever a product is bought or sold beyond its realprice for its worth, then inflation of money occurs.


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WHAT IS INFLATION?

General pricelevel

increases

Each unit ofcurrency buysfewer goods/

services

Erosion inpurchasingpower ofmoney


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MEASURING INFLATION

Inflation is rate of change in the price level.

If the price level in the current year is P1 and

in the previous year P0

.

The inflation for the current year is

[(P1 - P0) / P0] x 100


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EFFECTS OF INFLATION

Positive Effects Includes ensuring central banks can adjust nominal

interest rates.

Encouraging investment in non-monitory capitalprojects.

Less unemployment

Negative Effects

Includes a decrease in the real value of money and

other monetary items over time. Uncertainty over future inflation may discourage

investments and savings.

Rapid inflation may leads to shortage of goods out ofconcern that prices may increase in future.


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TYPES OF INFLATION

Inflation can be classified in terms of the rate at which prices

increase

Creeping Inflation

There is a marginal increase in prices. If it persists over a period of timewithout and monetary control, it may lead to running inflation

Running Inflation

The inflation rate is between 8 and 10%. There is an urgent need tocontrol inflation. Persistent running inflation reduces savings and results

in a slowdown.

Hyperinflation

It occurs when inflation touches the double digit mark. Hyperinflation canhamper the ability of an economy to supply goods and can lead to the

abandonment of the use of a countrys currency.


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HIGH INFLATION MAY LEAD THE COUNTRY

TO LOWER ECONOMIC GROWTH


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INFLATION IN INDIA

Between 1950-1960The inflation on an average was at 2.00%Between 1960-1970The inflation on an average was at 7.2%Between 1970-1980The inflation on an average was at 8.5%.


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WHOLESALE PRICE INDEX BASED INFLATIONRATE IN INDIA ON YEAR-ON-YEAR BASIS

0

1

2

3

4

5

6

7

8

9

10

Inflation Jan'11-Sep'12


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CURRENT SCENARIO OF INFLATION IN INDIA

Indias headline inflation was lowest for July12 which was6.87 %. The monthly inflation, based on wholesale priceindex (WPI), was 9.36 %.during the corresponding monthof the previous year.

Food articles have a 14.3 % share in the WPI basket andFood inflation had re-entered the double-digit zone after agap of six months in April, 2012 and only dropped tobelow 10% in Aug12

Pulses became costlier by 28.26 %. Milk became costlierby 8.01 %. Prices of eggs, meat and fish rose by 16.00 %.Y-O-Y July12.


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Recent factory data showed that Indiacontinued to face the problem of highinflationary pressure and a slow rate ofgrowth.

Data released by the Central Statistics Officerecently, Indias industrial output increased by2.7 % in Sep12.

Petrol as an item has lower weightage in theWPI of about 1.09 basis points and does not

primary impact the headline inflation.

CURRENT SCENARIO OF INFLATION IN INDIA


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INFLATION IN INDIA

Inflation accelerated to a 10-month high inSeptember mainly due to increase in fuelprices, wheat and fruits.

RBI reduced the cash reserve ratio, by 25basis points releasing over Rs 16,000 cr.

The decline in the exchange rate value of therupee makes imports expensive.


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INFLATION IN INDIA

In India, even as the growth has come down,

our inflation has not come down.

Rupee devaluation is due to widening trade

and current account deficits and slowdown in

portfolio flows on account of escalation in

euro crisis.


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Demand Pull Inflation

The general rise in price level is becausethe demand for goods and services is in

excess of the available supply at existing

prices.

The reasons for the shift in AD curve can

be either real or monetary factors.

It is due to:

The real factors

The monetary factorsAD0

AD1

AS

P0

P1

Y0

Y2

Y1

O X

Y

Price

Level


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Demand pull inflation can be shown in a diagramsuch as the one below.


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Causes of Demand Pull Inflation

Possible causes of demand pull inflation A growing economy: people will get better jobs and

will spend more

A depreciation of the exchange rate Exports are more competitive in overseas markets leading to an

injection of fresh demand into the circular flow and a rise in

national and demand for factor resources there may also be a

positive multiplier effect on the level of demand and outputarising from the initial boost to export sales

Technological innovation


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Reduction in direct or indirect taxation by thegovernment

If direct taxes are reduced, consumers will have more

disposable income causing demand to rise. Higher

government spending and increased borrowing feeds

through directly into extra demand in the circular flow.

Monetary stimulus to the economy

A fall in interest rates may stimulate too much demand

for example in raising demand for loans or in causing rise

in house price inflation


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Faster economic growth in other countriesproviding a boost to UK exports overseas.

Improved business confidence which prompts

firms to raise prices and achieve better profitmargins

Demand pull inflation is most likely to occur when aneconomy is becoming stretched and is said to be

danger of over-heating. This is often seen towards theend of a boom when output is expanding beyond theeconomys usual capacity to supply, the result beinghigher prices and also a larger trade deficit (importsact as a kind of safety valve to take away some of the

excess AD).


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Cost push theory of inflation

Cost-push inflation occurs when

businesses respond to rising costs, by

increasing their prices to protect profit

margins.

This creates a wide gap between the

aggregate demand and aggregate

supply.


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Cost push theory of inflation explains thecauses of inflation origination from the supply

side.

Cost push inflation depends on: Wage push inflation

Profit push inflation

Supply shock inflation

AS0

AS1

AD

P0

P1

Q

0

Q

1

O X

Y

Price

Level

Quantity


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Wage push inflation: Created by labor unionsand workers who are often able to increase theirwages faster than their productivity

Profit push inflation: Business firms pricing the

goods and services on sole basis of their directcost of materials and labor. In other words,aggressively motivated towards profit margin

Supply Shock inflation: the basic concept ofsupply-shock inflation has to do with aconsiderable increase in the cost of goods andservices that are considered to be essential and

somewhat difficult to substitute.


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Cost-push inflation occurs when businesses respond to rising costs, by

increasing their prices to protect profit margins. There are many reasonswhy costs might rise:

Component costs: e.g. an increase in the prices of raw materials and

components. This might be because of a rise in global commodity prices

such as oil, gas copper and agricultural products used in food processinga good recent example is the surge in the world price of wheat.

Rising labour costs - caused by wage increases that exceed improvements

in productivity. Wage and salary costs often rise when unemployment is low

(creating labour shortages) and when people expect inflation so they bid for

higher pay in order to protect their real incomes.

Higher indirect taxes imposed by the government for example a rise in the

duty on alcohol, cigarettes and petrol/diesel or a rise in the standard rate of

Value Added Tax. Depending on the price elasticity of demand and supply,

suppliers may pass on the burden of the tax onto consumers.


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Cost push theory of inflation A fall in the exchange rate this can cause cost push inflation

because it normally leads to an increase in the prices of importedproducts. For example during 2007-08 the pound fell heavily

against the Euro leading to a jump in the prices of imported

materials from Euro Zone countries.

Cost-push inflation can be illustrated by an inward shift of theshort run aggregate supply curve. The fall in SRAS causes a

contraction of GDP together with a rise in the level of prices. One

of the risks of cost-push inflation is that it can lead to stagflation.

Important note: Many of the causes of cost-push inflation come

from external economic shocks e.g. unexpected volatility in the

prices of internationally traded commodities and large-scale

movements in variables such as the exchange rate. A country

can also import cost-push inflation from another country that is

suffering from rising inflation of its own.


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Demand pull vs Cost Push

Inflation One difference between the demand pull

and cost push inflations is the

unemployment level.

In demand pull inflation the unemployment

level remains low, whereas in the cost

push inflation the unemployment level is

on rise.


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Demand pull vs Cost Push

Inflation If demand pull inflation is correct the

government must bear the cost of excessivespending and monetary authorities are to be

blamed for cheap money policy

On the contrary, if cost push is the real causefor inflation then the trade union are to

blamed for excessive wage claim, industriesfor acceding them and business firms formarking-up profits aggressively.


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THE PHILLIPS CURVE Phillips Curve by A.W. Phillips shows that there is a inverse

relationship between the rate of money wage increases and

the rate of unemployment of the labor force.


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CHARACTERISTICS OF PHILLIPS CURVE

Its a downward sloping curve towards theright.

The decline in the rate of unemployment fromU1 to U2 would increase the rate of wage

increase from P1 to P2 which in turn causesinflation to increase.

If the wage push inflation is to be kept under

control , the society should be willing toaccept certain amount of unemployment.

The increase in the rate of unemploymentwould reduce the rate of wage increases

leading to price stability.


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EXPLANATIONS OF PHILLIPS CURVERELATIONSHIP

In terms of Behaviour of Organised Labour :

When unemployment rate is low and labour

market is tight, the demands for good is high

and hence producers make good profits.Thus the wages of the labour increases under

such conditions.

When unemployment rate is high , due to themarket conditions the demand is low hence

profits are low. The wages of labor are not

increased .


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IN TERMS OF EXCESS DEMAND FOR LABOUR: R.G Lipsey shows at at point W3, the supply of labour is

equal to the demand of the labour .

This implies that unemployment is not zero but the numberof unemployed workers is exactly same as the number of

jobs lying vacant. The rate of wage increases directly with the amount of the

excess demand of labour.

Unemployment varies inversely with the amount of excessdemand.

Hence wage rate varies inversely with unemployment rate.

Below the point W3 there is an excess demand for labourwhich means a lower unemployment rate and also a higherrate of wage increase. Vice versa for above W3


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MEASURING INFLATION

Inflation is usually measured based on certain indices. Broadly, there are two categories of indices for

measuring inflation -

Wholesale Prices and Consumer Prices.

An Index numberis a single figure that shows how thewhole set of related variables has changed over time orfrom one place to another. In particular, a price indexreflects the overall change in a set of prices paid by aconsumer or a producer, and is conventionally known

as a Cost-of-Living index or Producer's Price Index asthe case may be.


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WHOLESALE PRICE INDEX (WPI)

The Wholesale Price Index is an indicatordesigned to measure the changes in theprice levels of commodities that flow into thewholesale trade intermediaries.

In India about 676 items were used forcalculating the WPI in base year.

It is also the price index which is available ona weekly basis with the shortest possibletime lag only two weeks.


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WHOLESALE PRICE INDEX (WPI)

The index is a vital guide in economicanalysis and policy formulation.

It is a basis for price adjustments in businesscontracts and projects. It is also intended toserve as an additional source of informationfor comparisons on the international front.


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CONSUMER PRICE INDEX (CPI)

CPI is a statistical time-series measure of aweighted average of prices of a specified set

of goods and services purchased by

consumers.

Under CPI, an index is scaled so that it is

equal to 100 at a chosen point in time, so

that all other values of the index are a

percentage relative to this one.


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CONSUMER PRICE INDEX (CPI)

It shows the cost of living of the group.

It is based on the changes in the retail pricesof goods or services. Based on their

incomes, consumer spends money on theseparticular set of goods and services.

There are different consumer price indices.Each index tracks the changes in the retailprices for different set of consumers. Thereason for the different indices is the differingpattern of consumers.


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WRT INDIA.

India is the only major country that uses awholesale index to measure inflation.

Most countries use the CPI as a measure ofinflation, as this actually measures the increase in

price that a consumer will ultimately have to pay for.

WPI does not properly measure the exact price risean end-consumer will experience because, as the

same suggests, it is at the wholesale level.

The WPI doesnt take the price of services intoconsideration, which now accounts for 55% percent

of the GDP.


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WRT INDIA.

Take, for example, a commodity like coarsegrains that go into making of livestock feed.

This commodity is insignificant, but continues

to be considered while measuring inflation.

WPI is supposed to measure impact of

prices on business. But we use it to measure

the impact on consumers. Many commodities

not consumed by consumers get calculatedin the index.


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WHY INDIA IS NOT SWITCHING OVER TO THE CPI

METHOD OF CALCULATING INFLATION?

Finance ministry officials pointed out thatthere are many intricate problems from

shifting from WPI to CPI model.

First of all, they say, in India, there are fourdifferent types of CPI indices, and that makes

switching over to the Index from WPI fairly

'risky and unwieldy.' The four CPI series are: CPI Industrial

Workers; CPI Urban Non-Manual

Employees; CPI Agricultural labourers; and


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WHY INDIA IS NOT SWITCHING OVER TO THE CPI

METHOD OF CALCULATING INFLATION?

Secondly, officials say the CPI cannot be

used in India because there is too much of a

lag in reporting CPI numbers.

The WPI is published on a weekly basis andthe CPI, on a monthly basis.

And in India, inflation is calculated on a

weekly basis.


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THE CHANGE..

The Consumer Price Index (CPI), was introduced ayear ago, and it will exist alongside the prevailing

Wholesale Price Index (WPI).

The CPI rate was introduced keeping in mind thatdemand-side pricing would be a better indicator of

inflation than the WPI, which focuses on prices

from the producers' side.

The CPI data tracks retail prices in five majorgroups, food, fuel, clothing, housing and education

across rural and urban India, providing a

comprehensive reference point for policymakers.


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THE CHANGE..

The CPI also reflects price movements in the

services sector, which makes up about 55

per cent of India's economy but is not

included in the WPI.

The index, which uses 2010 as the base

year, was introduced by the Ministry of

Statistics in January 2011.

Indias first ever annual inflation rate, basedon the consumer price index (CPI), was 7.65

per cent for the month of January 2012


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ISSUES

India now has three consumer indices CPI forindustrial workers (IW), for agricultural labourers

(AL) and rural labourers (RL) to reflect price

increases for three different segments. This makes

it difficult for the Indian government to adopt CPI in

calculating inflation

Then, there is too much of a lag in reporting of CPI

numbers. India calculates inflation on weekly basis,whereas CPI figures are available on monthly

basis. Thus, the economists are sure that it would

take lot of time for Indian government to eventually

have one CPI index incorporating all indices.


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ISSUES

Given a choice, even Indian policymakers wouldwant to shift to the wide and comprehensiveindex as it better reflects the demand-sidepressures, an important ingredient in making

policy to tackle inflation The RBI governor D Subbarao, too had recently

said that the central bank has opted for WPIover CPI as a second-best choice. Although the

CPI is the most representative of the pricesituation in the country, experts expect RBI willnot abandon WPI as the primary inflation sourceanytime soon.


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MEASURES TO CONTROL INFLATION

There are various measures by which the inflationcan be controlled. These measures can be

classified into -

Monetary measures,

Fiscal measures and

Other measures.


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MONETORY MEASURES

Monetory Policy refers to the policy measures thataffect the economic variables viz. output, prices, etcthrough change in money supply

RBI

The monetory policy includes a range of instruments :-(i) Cash Reserve Ratio (CRR)

(ii) Statutory Liquid Ratio (SLR)

(iii) Bank Rate

(iv) Open Market Operations


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MONETORY MEASURES TO CONTROL INFLATION ININDIA

Other monetory policy measures:(i) Modifications in SLR and restoring it to 23% of net

demand and time liabilities (NDTL) of the banks.

(ii) Bank Rate: Decreased from 9.50% to 9.00%which was continuing since 13/02/2012

(iii) CRR: Decreased from 4.50%which was

continuing since 22/09/2012

(iv) SLR: Decreased from 24% which was continuingsince 18/12/2010


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FISCAL MEASURES

The fiscal policy covers the policy of theGovernment relating to its expenditure andrevenues and includes instruments like

(i) taxation,

(ii) subsidies,

(iii) public expenditure


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FISCAL MEASURES

Measures taken by the government to control inflation.

Decrease in public expenditure- One of the main reasons of inflation

is excess public expenditure like building of roads ,bridges etc.

Government should drastically scale down its non essential expenditure

.

Delay in payment of old debts: Payment of old debts that fall due

should be postponed for sometime so that people may not acquire

extra purchasing power.

Increase in taxes : Government should levy some new direct taxes and

raise rates of old taxes.

Over valuation of money : To control the over valuation of money it is


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AMINISTRATIVE MEASURE

Apart from monetory and fiscal policiescertain administrative policies like rationing,

price control, opening fair price shops, check

on hoarding etc help to augment marketsupply and reduce inflationary prices


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AMINISTRATIVE MEASURE TO CONTROL INFLATIONIN INDIA

Public Distribution System (PDS)i. To help people purchase wheat, rice, etc at reasonable price the govt has opened

around 4.47 lakh fair price shops

ii. It ensures that the common people are assured of the supply of neccesary goods atlower prices

Checking Hoardingi. Govt must unearth hoardings and punish hoarders and speculators to

ease pressure on prices

Other Measures :i. Ban on export of non basmati rice, edible oils and pulses.ii. Increasing minimum support prices (MSPs) with a view to encourage acreage under

food crops, increased production and more procurement.

iii. Distribution of imported pulses through PDS at subsidised rates.


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OTHER MEASURES:

1. Other measures primarily include price control and rationing andwage policy.Government sometimes puts temporary freeze on the earnings of theworkers and employees, so that the purchasing power can be curbed.Example: Government of India imposed, temporary freeze on the leavetravel Concession (LTC) for its employees.

2. Increase in the production- One of the major causes of the inflation isthe excess of demand over supply ,so those goods should beproduced more whose prices are likely to rise rapidly .In order toincrease production public sector should be expanded and privatesector should be given more incentives.

3. Proper commercial policy- Those goods which are in scarcity shouldbe imported as much as possible from other countries and their exportshould be discouraged.

4. Encouragement to savings During inflation government should comeout with attractive saving schemes. It may issue 5 or 10 year bonds inorder to attract savings.


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IMPACT OF INFLATION

Right from the beginning, inflation adds toinequalities of income and wealth.

Every economy needs a continuous addition toits productive capacity for which it shouldencourage capital formation. Inflation makesconsumption more attractive than saving.

When domestic prices rise faster than prices inforeign countries, exports tend to lag behindimports then rate of exchanges depreciates.


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IMPACT OF INFLATION

High inflation distorts economic incentives bydiverting resources away from productive

investment to speculative activities.

Inflation reduces households saving leading to

fall in overall investment in the economy which

reduces its growth potential.

Nominal interest rates tend to be higher than

they would have been under low and stable


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IMPACT OF INFLATION

It affects external competitiveness throughappreciation of the real exchange rate.

It leads to an increase in unemployment and a fall in

output.

High inflation can prompt employees to demandrapid wage increases, to keep up with consumerprices.(Cost-push inflation)

People buy durable and/or non-perishablecommodities and other goods as stores ofwealth.(Hoarding)


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IMPACT OF INFLATION

Debtors and Creditors :As a result of theinflation the real value of money comesdown.

While paying back the loans taken,debtors do not consider the reduction inthe value of money as a result of theinflation.

Hence, debtors gain as a result of theinflation, whereas, creditors stand at theloosin end.


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Inflation - Group 1