Description
This is a report describing inflation trends and challenges.
Inflation: Trends and Challenges
-Jay Shah (MMS B-147)
Contents
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1 2 3 4 5 6 7 8 9 What is inflation Types of inflation Effects of inflation Causes of inflation Measurement of inflation Inflation in India Inflation in other countries How to curb Inflation Bibliography
Topic
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2 3 5 8 10 12 14 16 20
1
What is inflation?
Inflation is an increase in the price of a basket of goods and services that is representative of the economy as a whole. Inflation is also defined as a rise in the general level of prices of goods and services in an economy over a period of time. It is measured as the percentage rate of change of a price index. When the price level rises, each unit of currency buys fewer goods and services; consequently, inflation is also an erosion in the purchasing power of money – a loss of real value in the internal medium of exchange and unit of account in the economy. Inflation originally referred to increases in the amount of money in circulation. For instance, when gold was used as currency, the government could collect gold coins, melt them down, mix them with other metals such as silver, copper or lead, and reissue them at the same nominal value. By diluting the gold with other metals, the government could issue more coins without also needing to increase the amount of gold used to make them. When the cost of each coin is lowered in this way, the government profits from an increase in face value of a coin and the cost of producing, distributing and retiring it from circulation.. This practice would increase the money supply but at the same time the relative value of each coin would be lowered. As the relative value of the coins becomes less, consumers would need to give more coins in exchange for the same goods and services as before. These goods and services would experience a price increase as the value of each coin is reduced. As inflation rises, every rupee will buy a smaller percentage of a good. For example, if the inflation rate is 2%, then a Re1 pack of gum will cost Re1.02 in a year.
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Types of Inflation
There are four main types of inflation. The various types of inflation are briefed below. Cost-push Inflation: As the name suggests, if there is increase in the cost of production of goods and services, there is likely to be a forceful increase in the prices of finished goods and services. For instance, a rise in the wages of laborers would raise the unit costs of production and this would lead to rise in prices for the related end product. This type of inflation may or may not occur in conjunction with demand-pull inflation. Wage Inflation: Wage inflation is also called as demand-pull or excess demand inflation. This type of inflation occurs when total demand for goods and services in an economy exceeds the supply of the same. When the supply is less, the prices of these goods and services would rise, leading to a situation called as demand-pull inflation. This type of inflation affects the market economy adversely during the wartime. Sectoral Inflation: This is the fourth major type of inflation. The sectoral inflation takes place when there is an increase in the price of the goods and services produced by a certain sector of industries. For instance, an increase in the cost of crude oil would directly affect all the other sectors, which are directly related to the oil industry. Thus, the ever-increasing price of fuel has become an important issue related to the economy all over the world. Take the example of aviation industry. When the price of oil increases, the ticket fares would also go up. This would lead to a widespread inflation throughout the economy, even though it had originated in one basic sector. If this situation occurs when there is a recession in the economy, there would be layoffs and it would adversely affect the work force and the economy in turn. Pricing Power Inflation: Pricing power inflation is more often called as administered price inflation. This type of inflation occurs when the business houses and industries decide to increase the price of their respective goods and services to increase their profit margins. A point noteworthy is pricing power inflation does not occur at the time of financial crises and economic depression, or when there is a downturn in the economy. This type of inflation is also called as oligopolistic inflation because oligopolies have the power of pricing their goods and services.
Other Types of Inflation Fiscal Inflation: Fiscal Inflation occurs when there is excess government spending. This occurs when there is a deficit budget. For instance, Fiscal inflation originated in the US in 1960s at the time President Lydon Baines Johnson. America is also facing fiscal type of inflation under the
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presidentship of George W. Bush due to excess spending in the defense sector. Hyperinflation: Hyperinflation is also known as runaway inflation or galloping inflation. This type of inflation occurs during or soon after a war. This can usually lead to the complete breakdown of a country’s monetary system. However, this type of inflation is short-lived. In 1923, in Germany, inflation rate touched approximately 322 percent per month with October being the month of highest inflation. Example of hyperinflation: Angola went through its worst inflation from 1991 to 1995. In early 1991, the highest denomination was 50,000 kwanzas. By 1994, it was 500,000 kwanzas. In the 1995 currency reform, 1 readjusted kwanza was exchanged for 1,000 kwanzas. The highest denomination in 1995 was 5,000,000 readjusted kwanzas. In the 1999 currency reform, 1 new kwanza was exchanged for 1,000,000 readjusted kwanzas. The overall impact of hyperinflation: 1 new kwanza = 1,000,000,000 pre 1991 kwanzas. Deflation: Opposite to inflation is deflation, deflation is a decrease in the general price level of goods and services. Deflation can also be called as negative inflation.
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Effects of Inflation
An increase in the general level of prices implies a decrease in the purchasing power of the currency. That is, when the general level of prices rises, each monetary unit buys fewer goods and services. The effect of inflation is not distributed evenly in the economy, and as a consequence there are hidden costs to some and benefits to others from this decrease in the purchasing power of money. Increases in the price level (inflation) erodes the real value of money (the functional currency) and other items with an underlying monetary nature (e.g. loans and bonds). However, inflation has no effect on the real value of non-monetary items, (e.g. goods and commodities, gold, real estate).
Bad effects:
High or unpredictable inflation rates are regarded as harmful to an overall economy. They add inefficiencies in the market, and make it difficult for companies to budget or plan long-term. Inflation can act as a drag on productivity as companies are forced to shift resources away from products and services in order to focus on profit and losses from currency inflation. Uncertainty about the future purchasing power of money discourages investment and saving. And inflation can impose hidden tax increases, as inflated earnings push taxpayers into higher income tax rates.
The most immediate effect of inflation is the decrease in the purchasing power of dollar and its depreciation. Inflation influences the investments of a country. The Inflation-protected Securities (IPSs) may act as a guard against the loss in the purchasing power of the fixedincome investments (like fixed allowances and bonds), which may occur during inflation. Hoarding People buy consumer durables as stores of wealth in the absence of viable alternatives as a means of getting rid of excess cash before it is devalued, creating shortages of the hoarded objects. Cost-push inflation Rising inflation can prompt employees to demand higher wages, to keep up with consumer prices. Rising wages in turn can help fuel inflation. In the case of collective bargaining, wages will be set as a factor of price expectations, which will be higher when inflation has an upward
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trend. This can cause a wage spiral (represents a vicious circle process in which different sides of the wage bargain try to keep up with inflation to protect real incomes). In a sense, inflation begets further inflationary expectations. Hyperinflation If inflation gets totally out of control (in the upward direction), it can grossly interfere with the normal workings of the economy, hurting its ability to supply. Hyperinflation is inflation that is very high or "out of control", a condition in which prices increase rapidly as a currency loses its value Allocative efficiency Buyers and sellers that they should re-allocate resources in response to the new market conditions. But when prices are constantly changing due to inflation, genuine price signals get lost in the noise, so agents are slow to respond to them. The result is a loss of allocative efficiency. Allocative efficiency is a theoretical measure of the benefit or utility derived from a proposed or actual choice in the distribution or apportionment of resources Business cycles According to the Austrian Business Cycle Theory, inflation sets off the business cycle. Austrian economists hold this to be the most damaging effect of inflation. According to Austrian theory, artificially low interest rates and the associated increase in the money supply lead to reckless, speculative borrowing, resulting in clusters of malinvestments, which eventually have to be liquidated as they become unsustainable
Shoe leather cost High inflation increases the opportunity cost of holding cash balances and can induce people to hold a greater portion of their assets in interest paying accounts. However, since cash is still needed in order to carry out transactions this means that more "trips to the bank" are necessary in order to make withdrawals, proverbially wearing out the "shoe leather" with each trip. Menu costs With high inflation, firms must change their prices often in order to keep up with economy wide changes. But often changing prices is itself a costly activity whether explicitly, as with the need to print new menus, or implicitly.
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menu costs are the costs to firms of updating menus, price lists, brochures, and other materials when prices change in an economy. Because this transaction cost exists, firms sometimes do not change their prices when the economy puts pressure on it, leading to price stickiness.
Good Effects:
Debt relief Debtors who have debts with a fixed nominal rate of interest will see a reduction in the "real" interest rate as the inflation rate rises. The “real” interest on a loan is the nominal rate minus the inflation rate (R=n-i) For example if you take a loan where the stated interest rate is 6% and the inflation rate is at 3%, the real interest rate that you are paying for the loan is 3%. It would also hold true that if you had a loan at a fixed interest rate of 6% and the inflation rate jumped to 20% you would have a real interest rate of -14%. Banks and other lenders adjust for this inflation risk either by including an inflation premium in the costs of lending the money by creating a higher initial stated interest rate or by setting the interest at a variable rate. Labor-market adjustments Keynesians believe that nominal wages are slow to adjust downwards. This can lead to prolonged disequilibrium and high unemployment in the labor market. Since inflation would lower the real wage if nominal wages are kept constant, Keynesians argue that some inflation is good for the economy, as it would allow labor markets to reach equilibrium faster. Room to maneuver The primary tools for controlling the money supply are the ability to set the discount rate, the rate at which banks can borrow from the central bank, and open market operations which are the central bank's interventions into the bonds market with the aim of affecting the nominal interest rate. If an economy finds itself in a recession with already low, or even zero, nominal interest rates, then the bank cannot cut these rates further (since negative nominal interest rates are impossible) in order to stimulate the economy - this situation is known as a liquidity trap. A moderate level of inflation tends to ensure that nominal interest rates stay sufficiently above zero so that if the need arises the bank can cut the nominal interest rate.
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Causes of inflation
There are many causes for inflation: Keynesian economic theory proposes that changes in money supply do not directly affect prices, and that visible inflation is the result of pressures in the economy expressing themselves in prices. The supply of money is a major, but not the only, cause of inflation.
Demand Pull theory attribute a rise in prices to an increase in demand in excess of the supplies available. An increase in the quantity of money in circulation relative to the ability of the economy to supply leads to increased demand, thereby fuelling prices. The case is of too much money chasing too few goods. An increase in demand could also be a result of declining interest rates, a cut in tax rates or increased consumer confidence. Demand-pull inflation is caused by increases in aggregate demand due to increased private and government spending, etc. Demand inflation is constructive to a faster rate of economic growth since the excess demand and favorable market conditions will stimulate investment and expansion. The Cost Push theory, on the other hand, states that inflation occurs when the cost of producing rises and the increase is passed on to consumers. The cost of production can rise because of rising labor costs or when the producing firm is a monopoly or oligopoly and raises prices, cost of imported raw material rises due to exchange rate changes, and external factors, such as natural calamities or an increase in the economic power of a certain country. Cost-push inflation, also called "supply shock inflation," is caused by a drop in aggregate supply (potential output). This may be due to natural disasters, or increased prices of inputs. For example, a sudden decrease in the supply of oil, leading to increased oil prices, can cause cost-push inflation. Producers for whom oil is a part of their costs could then pass this on to consumers in the form of increased prices. Built-in inflation is induced by adaptive expectations, and is often linked to the "price/wage spiral". It involves workers trying to keep their wages up with prices (above the rate of inflation), and firms passing these higher labor costs on to their customers as higher prices, leading to a 'vicious circle'. Built-in inflation reflects events in the past, and so might be seen as hangover inflation An increase in indirect taxes can also lead to increased production cost Since oil is used in every industry, a sharp rise in the price of oil leads to an increase in the prices of all commodities.
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While money growth is considered to be a principal long-term determinant of inflation, nonmonetary sources, such as an increase in commodity prices, have played a key role in triggering inflation in the past four decades. Inflation has become a major concern worldwide in 2008, with global prices rises in oil, food, steel and other commodities being the culprit. When the government of a country print money in excess, prices increase to keep up with the increase in currency, leading to inflation. Increase in production and labor costs, have a direct impact on the price of the final product, resulting in inflation. When countries borrow money, they have to cope with the interest burden. This interest burden results in inflation. High unemployment can be a cause of inflation too. Wars can also lead to inflation. Banks create more liquidity by allowing more loans for people, giving them the purchasing power to buy more, as a result of which prices are driven up further. The demand-supply gap also drives inflation rates.
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Measurement of inflation
Measuring inflation is a difficult problem for government statisticians. To do this, a number of goods that are representative of the economy are put together into what is referred to as a "market basket." The cost of this basket is then compared over time. This results in a price index, which is the cost of the market basket today as a percentage of the cost of that identical basket in the starting year.
Consumer Price Index (CPI) - A measure of price changes in consumer goods and services such as gasoline, food, clothing and automobiles. The CPI measures price change from the perspective of the purchaser. U.S. CPI data can be found at the Bureau of Labor Statistics. Producer Price Indexes (PPI) - A family of indexes that measure the average change over time in selling prices by domestic producers of goods and services. PPIs measure price change from the perspective of the seller. U.S. PPI data can be found at the Bureau of Labor Statistics. Core price indices: because food and oil prices can change quickly due to changes in supply and demand conditions in the food and oil markets, it can be difficult to detect the long run trend in price levels when those prices are included. Therefore most statistical agencies also report a measure of 'core inflation', which removes the most volatile components (such as food and oil) from a broad price index like the CPI. Because core inflation is less affected by short run supply and demand conditions in specific markets, central banks rely on it to better measure the inflationary impact of current monetary policy. Cost-of-living indices (COLI) are indices similar to the CPI which are often used to adjust fixed incomes and contractual incomes to maintain the real value of those incomes. GDP deflator is a measure of the price of all the goods and services included in Gross Domestic Product (GDP). The US Commerce Department publishes a deflator series for US GDP, defined as its nominal GDP measure divided by its real GDP measure. Commodity price indices, which measure the price of a selection of commodities. In the present commodity price indices are weighted by the relative importance of the components to the "all in" cost of an employee.
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Regional inflation The Bureau of Labor Statistics breaks down CPI-U calculations down to different regions of the US. Asset price inflation is an undue increase in the prices of real or financial assets, such as stock (equity) and real estate. While there is no widely-accepted index of this type, some central bankers have suggested that it would be better to aim at stabilizing a wider general price level inflation measure that includes some asset prices, instead of stabilizing CPI or core inflation only. The reason is that by raising interest rates when stock prices or real estate prices rise, and lowering them when these asset prices fall, central banks might be more successful in avoiding bubbles and crashes in asset prices. Historical inflation Before collecting consistent econometric data became standard for governments, and for the purpose of comparing absolute, rather than relative standards of living, various economists have calculated imputed inflation figures. Most inflation data before the early 20th century is imputed based on the known costs of goods, rather than compiled at the time. It is also used to adjust for the differences in real standard of living for the presence of technology. Wholesale Price Index (WPI) WPI was first published in 1902, and was one of the more economic indicators available to policy makers until it was replaced by most developed countries by the Consumer Price Index in the 1970s. WPI is the index that is used to measure the change in the average price level of goods traded in wholesale market. In India, a total of 435 commodities data on price level is tracked through WPI which is an indicator of movement in prices of commodities in all trade and transactions. It is also the price index which is available on a weekly basis with the shortest possible time lag only two weeks. The Indian government has taken WPI as an indicator of the rate of inflation in the economy.
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Inflation in India:
Inflation in India statistics
Year 2010 2009 2008 2007 2006
Jan 16.22 10.45 5.51 6.72 4.39
Feb 9.63 5.47 7.56 5.31
Mar 8.03 7.87 6.72 5.31
Apr 8.70 7.81 6.67 5.26
May 8.63 7.75 6.61 6.14
Jun 9.29 7.69 5.69 7.89
Jul 11.89 8.33 6.45 6.90
Aug 11.72 9.02 7.26 5.98
Sep 11.64 9.77 6.40 6.84
Oct 11.49 10.45 5.51 7.63
Nov 13.51 10.45 5.51 6.72
Dec 14.97 9.70 5.51 6.72
We can clearly see that inflation in India is on a rise and The food index in January-February was almost constant. The food inflation was pegged at 17.81% towards February-end. Sugar prices rose to 55.47% in February whereas potato and pulses turned costlier by 30% and 35.58% respectively. Fuel inflation shot up to 12.68 per cent.
This is how food prices have risen since 2007: Food articles: 7.02% (in 2007) to 17.41% in January 2010. Food products: 3.43% (in 2007) to 22.55% in January 2010. Food commodities: 5.60% (in 2007) to 19.42% in January 2010. Foodgrains: 6.27% (in 2007) to 17.89% in January 2010.
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Cereals: 6.27% (in 2007) to 13.69% in January 2010. Pulses: 2.14% (in 2007) to 45.62% in 2007 in January 2010. Rice: 6.05% (in 2007) to 12.02% in January 2010. Wheat: 6.77% (in 2007) to 14.86% in January 2010. Dairy products: 6.08% (in 2007) to 12.87% in January 2010. Eggs, fish and meat: 6.38% (in 2007) to 30.71% in January 2010. Sugar: (-)14.69% (in 2007) to 58.94% in January 2010. Inflation in Food and Non-food Commodities during 1994-95 to January 2010 (Based on WPI with base 1993-94) and Growth Rate in Food Output (%) Item 1994-95 to 2005 2004-05 4.74 2006 2007 2008 2009 2010 Average January 2006-09 8.54 5.19
1. All 5.90 commodities 2. Non-food 6.02 commodities 3. Food 5.91 articles 4. Food 5.33 products 5. Food 5.64 commodities (3 and 4) Foodgrains Cereals Pulses
Rice Wheat Oilseeds Fruits and
4.82
4.82
9.12
2.01
5.37
4.72
4.54
9.55
-1.76
4.53
4.27
3.94
6.83
7.02
6.64
12.32 17.41
8.20
1.58
2.55
3.43
9.80
13.79 22.55
7.39
2.97
5.09
5.60
7.87
12.90 19.42
7.86
5.54 5.57 5.46
5.00 5.93 5.89 7.47
3.83 3.68 5.04
4.01 1.08 -6.11 7.51
9.71 6.63 32.05
2.13 12.99 -3.96 2.24
6.27 6.97 2.14
6.05 6.77 26.58 6.49
6.37 7.20 1.30
8.97 5.06 17.46 5.94
14.14 17.89 12.96 13.69 21.81 45.62
15.96 6.83 0.92 11.77 12.02 14.86 10.05 8.33
9.12 8.44 14.33
8.28 7.91 10.25 6.61
vegetables Dairy 5.20 0.11 4.20 6.08 8.38 6.12 12.87 6.19
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products Milk group Egg, fish and meat Edible oils Sugar 4.85 4.06 -7.19 15.09 1.23 4.83 13.11 14.69 Growth food (%/a year) in 2.39 0.55 5.87 4.10 5.39 1.60 -02 AE 4.24 12.52 5.62 -6.59 36.34 -1.17 58.94 5.07 8.02 5.57 6.46 0.73 9.46 4.48 6.72 8.17 6.38 7.87 3.75 8.93 14.44 13.99 30.71 7.36 7.82
output
Inflation in India is also a grave issue of concern, given the vast disparity between the rich and the poor on the one hand or the Rural and the Urban on the other. Skyrocketing inflation robs the poor, and hurts others, though much less grievously. The fruits of the much-talked about economic growth have not reached large sections, especially in the rural areas.
Inflation in other countries.
Inflation rates in BRIC countries
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Inflation in major countries
India comes in at almost as high as 16.22% Lowest Inflation for the quarter till march 2010 Countries New Zealand UK Australia EU Japan US Current Inflation (%) 3 2.9 2.5 0.6 -0.3 -0.4
India can learn some things from these countries as how to reduce the inflation levels.
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How to curb Inflation?
A variety of methods have been used in attempts to control inflation.
Gold standard The gold standard is a monetary system in which a region's common media of exchange are paper notes that are normally freely convertible into pre-set, fixed quantities of gold. The standard specifies how the gold backing would be implemented, including the amount of specie per currency unit. The currency itself has no innate value, but is accepted by traders because it can be redeemed for the equivalent specie. A U.S. silver certificate, for example, could be redeemed for an actual piece of silver. The gold standard was partially abandoned via the international adoption of the Bretton Woods System. Under this system all other major currencies were tied at fixed rates to the dollar, which itself was tied to gold at the rate of $35 per ounce. The Bretton Woods system broke down in 1971, causing most countries to switch to fiat money – money backed only by the laws of the country. Austrian economists strongly favor a return to a 100 percent gold standard. Under a gold standard, the long term rate of inflation (or deflation) would be determined by the growth rate of the supply of gold relative to total output. Critics argue that this will cause arbitrary fluctuations in the inflation rate, and that monetary policy would essentially be determined by gold mining, which some believe contributed to the Great Depression. Monetary policy Today the primary tool for controlling inflation is monetary policy. Most central banks are tasked with keeping the federal funds lending rate at a low level, normally to a target rate around 2% to 3% per annum, and within a targeted low inflation range, somewhere from about 2% to 6% per annum. A low positive inflation is usually targeted, as deflationary conditions are seen as dangerous for the health of the economy. There are a number of methods that have been suggested to control inflation. . High interest rates and slow growth of the money supply are the traditional ways through which central banks fight or prevent inflation, though they have different approaches. For instance, some follow asymmetrical inflation target while others only control inflation when it rises above a target, whether express or implied.
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Monetarists emphasize keeping the growth rate of money steady, and using monetary policy to control inflation (increasing interest rates, slowing the rise in the money supply). Keynesians emphasize reducing aggregate demand during economic expansions and increasing demand during recessions to keep inflation stable. Control of aggregate demand can be achieved using both monetary policy and fiscal policy (increased taxation or reduced government spending to reduce demand).
Fiscal Policies: Fiscal policies are effective in increasing the leakage rates from the circular income flow, thereby rejecting all further additions into this particular flow of income. This brings about a reduction in the Demand-Pull Inflation, in terms of increasing unemployment and slackening the economic growths. Following are a few types of fiscal policies commonly employed: Lowering the expenses on governmental level A fall in the borrowing amounts in the government sectors, on an annual basis High direct taxes, for reducing the disposable income
Fixed exchange rates Under a fixed exchange rate currency regime, a country's currency is tied in value to another single currency or to a basket of other currencies (or sometimes to another measure of value, such as gold). A fixed exchange rate is usually used to stabilize the value of a currency, vis-a-vis the currency it is pegged to. It can also be used as a means to control inflation. However, as the value of the reference currency rises and falls, so does the currency pegged to it. This essentially means that the inflation rate in the fixed exchange rate country is determined by the inflation rate of the country the currency is pegged to. In addition, a fixed exchange rate prevents a government from using domestic monetary policy in order to achieve macroeconomic stability. Wage and price controls Another method attempted in the past have been wage and price controls ("incomes policies"). Wage and price controls have been successful in wartime environments in combination with rationing. However, their use in other contexts is far more mixed. In general wage and price controls are regarded as a temporary and exceptional measure, only effective when coupled with policies designed to reduce the underlying causes of inflation during the wage and price control regime, for example, winning the war being fought. They often have perverse effects, due to the distorted signals they send to the market. Artificially low prices often
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cause rationing and shortages and discourage future investment, resulting in yet further shortages. The usual economic analysis is that any product or service that is under-priced is overconsumed. For example, if the official price of bread is too low, there will be too little bread at official prices, and too little investment in bread making by the market to satisfy future needs, thereby exacerbating the problem in the long term. Temporary controls may complement a recession as a way to fight inflation: the controls make the recession more efficient as a way to fight inflation (reducing the need to increase unemployment), while the recession prevents the kinds of distortions that controls cause when demand is high. However, in general the advice of economists is not to impose price controls but to liberalize prices by assuming that the economy will adjust and abandon unprofitable economic activity. The lower activity will place fewer demands on whatever commodities were driving inflation, whether labor or resources, and inflation will fall with total economic output. This often produces a severe recession, as productive capacity is reallocated and is thus often very unpopular with the people whose livelihoods are destroyed (see creative destruction).
Agriculture In the case of agriculture, if productivity rises to international levels, we will have a glut. Hence, for agriculture too, good management will prevent inflation. Thus, inflation can be attributed to poor management. In 1991, India embarked on an era of liberalisation. We can see resultant benefits in the phenomenal improvement in quality (and decrease in prices) in the liberalised sectors of the economy. Unfortunately, even as parts of the economy were liberalized Farm sector is riddled with restrictions.
Change in method to calculate inflation According to many experts India has been following an incorrect method or an old method to calculate inflation(WPI) there must be a change in it(CPI) so as to calculate the amount and take steps accordingly Cost-of-living allowance The real purchasing-power of fixed payments is eroded by inflation unless they are inflationadjusted to keep their real values constant. In many countries, employment contracts, pension benefits, and government entitlements (such as social security) are tied to a cost-of-living index, typically to the consumer price index. A cost-of-living allowance (COLA) adjusts salaries based on changes in a cost-of-living index. Salaries are typically adjusted annually. They may also be tied to a cost-of-living index that varies by geographic location if the employee moves.
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Annual escalation clauses in employment contracts can specify retroactive or future percentage increases in worker pay which are not tied to any index. These negotiated increases in pay are colloquially referred to as cost-of-living adjustments or cost-of-living increases because of their similarity to increases tied to externally-determined indexes. Many economists and compensation analysts consider the idea of predetermined future "cost of living increases" to be misleading for two reasons: (1) For most recent periods in the industrialized world, average wages have increased faster than most calculated cost-of-living indexes, reflecting the influence of rising productivity and worker bargaining power rather than simply living costs, and (2) most cost-of-living indexes are not forward-looking, but instead compare current or historical data. A stronger rupee A stronger rupee helps reduce inflation because it lowers the import prices of oil, other raw materials and capital goods and this, in turn, lowers the cost of production. It also reduces the prices of import-competing goods, like steel. A related myth is that a strong rupee will kill the economy by hurting exporters. A stronger rupee does reduce the rupee value of export earnings but it also reduces the cost of imported inputs, and to the extent that it dampens inflation, it limits the need for interest-rate hikes. Moreover, exporters are in a robust position now.
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Bibliography:
www.investopedia.com www.economy-watch.com www.india-reports.com www.tradechakra.com www.wikipedia.org www.rediff.com www.yahoofinance.com http://in.finance.yahoo.com http://tutor2u.net www.businessmapofindia.com www.tradingeconomics.com www.euromonitor.com www.indexmundi.com www.commodityonline.com www.reuters.com www.inflationdata.com
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doc_378703708.pdf
This is a report describing inflation trends and challenges.
Inflation: Trends and Challenges
-Jay Shah (MMS B-147)
Contents
Sr
1 2 3 4 5 6 7 8 9 What is inflation Types of inflation Effects of inflation Causes of inflation Measurement of inflation Inflation in India Inflation in other countries How to curb Inflation Bibliography
Topic
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2 3 5 8 10 12 14 16 20
1
What is inflation?
Inflation is an increase in the price of a basket of goods and services that is representative of the economy as a whole. Inflation is also defined as a rise in the general level of prices of goods and services in an economy over a period of time. It is measured as the percentage rate of change of a price index. When the price level rises, each unit of currency buys fewer goods and services; consequently, inflation is also an erosion in the purchasing power of money – a loss of real value in the internal medium of exchange and unit of account in the economy. Inflation originally referred to increases in the amount of money in circulation. For instance, when gold was used as currency, the government could collect gold coins, melt them down, mix them with other metals such as silver, copper or lead, and reissue them at the same nominal value. By diluting the gold with other metals, the government could issue more coins without also needing to increase the amount of gold used to make them. When the cost of each coin is lowered in this way, the government profits from an increase in face value of a coin and the cost of producing, distributing and retiring it from circulation.. This practice would increase the money supply but at the same time the relative value of each coin would be lowered. As the relative value of the coins becomes less, consumers would need to give more coins in exchange for the same goods and services as before. These goods and services would experience a price increase as the value of each coin is reduced. As inflation rises, every rupee will buy a smaller percentage of a good. For example, if the inflation rate is 2%, then a Re1 pack of gum will cost Re1.02 in a year.
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Types of Inflation
There are four main types of inflation. The various types of inflation are briefed below. Cost-push Inflation: As the name suggests, if there is increase in the cost of production of goods and services, there is likely to be a forceful increase in the prices of finished goods and services. For instance, a rise in the wages of laborers would raise the unit costs of production and this would lead to rise in prices for the related end product. This type of inflation may or may not occur in conjunction with demand-pull inflation. Wage Inflation: Wage inflation is also called as demand-pull or excess demand inflation. This type of inflation occurs when total demand for goods and services in an economy exceeds the supply of the same. When the supply is less, the prices of these goods and services would rise, leading to a situation called as demand-pull inflation. This type of inflation affects the market economy adversely during the wartime. Sectoral Inflation: This is the fourth major type of inflation. The sectoral inflation takes place when there is an increase in the price of the goods and services produced by a certain sector of industries. For instance, an increase in the cost of crude oil would directly affect all the other sectors, which are directly related to the oil industry. Thus, the ever-increasing price of fuel has become an important issue related to the economy all over the world. Take the example of aviation industry. When the price of oil increases, the ticket fares would also go up. This would lead to a widespread inflation throughout the economy, even though it had originated in one basic sector. If this situation occurs when there is a recession in the economy, there would be layoffs and it would adversely affect the work force and the economy in turn. Pricing Power Inflation: Pricing power inflation is more often called as administered price inflation. This type of inflation occurs when the business houses and industries decide to increase the price of their respective goods and services to increase their profit margins. A point noteworthy is pricing power inflation does not occur at the time of financial crises and economic depression, or when there is a downturn in the economy. This type of inflation is also called as oligopolistic inflation because oligopolies have the power of pricing their goods and services.
Other Types of Inflation Fiscal Inflation: Fiscal Inflation occurs when there is excess government spending. This occurs when there is a deficit budget. For instance, Fiscal inflation originated in the US in 1960s at the time President Lydon Baines Johnson. America is also facing fiscal type of inflation under the
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presidentship of George W. Bush due to excess spending in the defense sector. Hyperinflation: Hyperinflation is also known as runaway inflation or galloping inflation. This type of inflation occurs during or soon after a war. This can usually lead to the complete breakdown of a country’s monetary system. However, this type of inflation is short-lived. In 1923, in Germany, inflation rate touched approximately 322 percent per month with October being the month of highest inflation. Example of hyperinflation: Angola went through its worst inflation from 1991 to 1995. In early 1991, the highest denomination was 50,000 kwanzas. By 1994, it was 500,000 kwanzas. In the 1995 currency reform, 1 readjusted kwanza was exchanged for 1,000 kwanzas. The highest denomination in 1995 was 5,000,000 readjusted kwanzas. In the 1999 currency reform, 1 new kwanza was exchanged for 1,000,000 readjusted kwanzas. The overall impact of hyperinflation: 1 new kwanza = 1,000,000,000 pre 1991 kwanzas. Deflation: Opposite to inflation is deflation, deflation is a decrease in the general price level of goods and services. Deflation can also be called as negative inflation.
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Effects of Inflation
An increase in the general level of prices implies a decrease in the purchasing power of the currency. That is, when the general level of prices rises, each monetary unit buys fewer goods and services. The effect of inflation is not distributed evenly in the economy, and as a consequence there are hidden costs to some and benefits to others from this decrease in the purchasing power of money. Increases in the price level (inflation) erodes the real value of money (the functional currency) and other items with an underlying monetary nature (e.g. loans and bonds). However, inflation has no effect on the real value of non-monetary items, (e.g. goods and commodities, gold, real estate).
Bad effects:
High or unpredictable inflation rates are regarded as harmful to an overall economy. They add inefficiencies in the market, and make it difficult for companies to budget or plan long-term. Inflation can act as a drag on productivity as companies are forced to shift resources away from products and services in order to focus on profit and losses from currency inflation. Uncertainty about the future purchasing power of money discourages investment and saving. And inflation can impose hidden tax increases, as inflated earnings push taxpayers into higher income tax rates.
The most immediate effect of inflation is the decrease in the purchasing power of dollar and its depreciation. Inflation influences the investments of a country. The Inflation-protected Securities (IPSs) may act as a guard against the loss in the purchasing power of the fixedincome investments (like fixed allowances and bonds), which may occur during inflation. Hoarding People buy consumer durables as stores of wealth in the absence of viable alternatives as a means of getting rid of excess cash before it is devalued, creating shortages of the hoarded objects. Cost-push inflation Rising inflation can prompt employees to demand higher wages, to keep up with consumer prices. Rising wages in turn can help fuel inflation. In the case of collective bargaining, wages will be set as a factor of price expectations, which will be higher when inflation has an upward
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trend. This can cause a wage spiral (represents a vicious circle process in which different sides of the wage bargain try to keep up with inflation to protect real incomes). In a sense, inflation begets further inflationary expectations. Hyperinflation If inflation gets totally out of control (in the upward direction), it can grossly interfere with the normal workings of the economy, hurting its ability to supply. Hyperinflation is inflation that is very high or "out of control", a condition in which prices increase rapidly as a currency loses its value Allocative efficiency Buyers and sellers that they should re-allocate resources in response to the new market conditions. But when prices are constantly changing due to inflation, genuine price signals get lost in the noise, so agents are slow to respond to them. The result is a loss of allocative efficiency. Allocative efficiency is a theoretical measure of the benefit or utility derived from a proposed or actual choice in the distribution or apportionment of resources Business cycles According to the Austrian Business Cycle Theory, inflation sets off the business cycle. Austrian economists hold this to be the most damaging effect of inflation. According to Austrian theory, artificially low interest rates and the associated increase in the money supply lead to reckless, speculative borrowing, resulting in clusters of malinvestments, which eventually have to be liquidated as they become unsustainable
Shoe leather cost High inflation increases the opportunity cost of holding cash balances and can induce people to hold a greater portion of their assets in interest paying accounts. However, since cash is still needed in order to carry out transactions this means that more "trips to the bank" are necessary in order to make withdrawals, proverbially wearing out the "shoe leather" with each trip. Menu costs With high inflation, firms must change their prices often in order to keep up with economy wide changes. But often changing prices is itself a costly activity whether explicitly, as with the need to print new menus, or implicitly.
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menu costs are the costs to firms of updating menus, price lists, brochures, and other materials when prices change in an economy. Because this transaction cost exists, firms sometimes do not change their prices when the economy puts pressure on it, leading to price stickiness.
Good Effects:
Debt relief Debtors who have debts with a fixed nominal rate of interest will see a reduction in the "real" interest rate as the inflation rate rises. The “real” interest on a loan is the nominal rate minus the inflation rate (R=n-i) For example if you take a loan where the stated interest rate is 6% and the inflation rate is at 3%, the real interest rate that you are paying for the loan is 3%. It would also hold true that if you had a loan at a fixed interest rate of 6% and the inflation rate jumped to 20% you would have a real interest rate of -14%. Banks and other lenders adjust for this inflation risk either by including an inflation premium in the costs of lending the money by creating a higher initial stated interest rate or by setting the interest at a variable rate. Labor-market adjustments Keynesians believe that nominal wages are slow to adjust downwards. This can lead to prolonged disequilibrium and high unemployment in the labor market. Since inflation would lower the real wage if nominal wages are kept constant, Keynesians argue that some inflation is good for the economy, as it would allow labor markets to reach equilibrium faster. Room to maneuver The primary tools for controlling the money supply are the ability to set the discount rate, the rate at which banks can borrow from the central bank, and open market operations which are the central bank's interventions into the bonds market with the aim of affecting the nominal interest rate. If an economy finds itself in a recession with already low, or even zero, nominal interest rates, then the bank cannot cut these rates further (since negative nominal interest rates are impossible) in order to stimulate the economy - this situation is known as a liquidity trap. A moderate level of inflation tends to ensure that nominal interest rates stay sufficiently above zero so that if the need arises the bank can cut the nominal interest rate.
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Causes of inflation
There are many causes for inflation: Keynesian economic theory proposes that changes in money supply do not directly affect prices, and that visible inflation is the result of pressures in the economy expressing themselves in prices. The supply of money is a major, but not the only, cause of inflation.
Demand Pull theory attribute a rise in prices to an increase in demand in excess of the supplies available. An increase in the quantity of money in circulation relative to the ability of the economy to supply leads to increased demand, thereby fuelling prices. The case is of too much money chasing too few goods. An increase in demand could also be a result of declining interest rates, a cut in tax rates or increased consumer confidence. Demand-pull inflation is caused by increases in aggregate demand due to increased private and government spending, etc. Demand inflation is constructive to a faster rate of economic growth since the excess demand and favorable market conditions will stimulate investment and expansion. The Cost Push theory, on the other hand, states that inflation occurs when the cost of producing rises and the increase is passed on to consumers. The cost of production can rise because of rising labor costs or when the producing firm is a monopoly or oligopoly and raises prices, cost of imported raw material rises due to exchange rate changes, and external factors, such as natural calamities or an increase in the economic power of a certain country. Cost-push inflation, also called "supply shock inflation," is caused by a drop in aggregate supply (potential output). This may be due to natural disasters, or increased prices of inputs. For example, a sudden decrease in the supply of oil, leading to increased oil prices, can cause cost-push inflation. Producers for whom oil is a part of their costs could then pass this on to consumers in the form of increased prices. Built-in inflation is induced by adaptive expectations, and is often linked to the "price/wage spiral". It involves workers trying to keep their wages up with prices (above the rate of inflation), and firms passing these higher labor costs on to their customers as higher prices, leading to a 'vicious circle'. Built-in inflation reflects events in the past, and so might be seen as hangover inflation An increase in indirect taxes can also lead to increased production cost Since oil is used in every industry, a sharp rise in the price of oil leads to an increase in the prices of all commodities.
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While money growth is considered to be a principal long-term determinant of inflation, nonmonetary sources, such as an increase in commodity prices, have played a key role in triggering inflation in the past four decades. Inflation has become a major concern worldwide in 2008, with global prices rises in oil, food, steel and other commodities being the culprit. When the government of a country print money in excess, prices increase to keep up with the increase in currency, leading to inflation. Increase in production and labor costs, have a direct impact on the price of the final product, resulting in inflation. When countries borrow money, they have to cope with the interest burden. This interest burden results in inflation. High unemployment can be a cause of inflation too. Wars can also lead to inflation. Banks create more liquidity by allowing more loans for people, giving them the purchasing power to buy more, as a result of which prices are driven up further. The demand-supply gap also drives inflation rates.
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Measurement of inflation
Measuring inflation is a difficult problem for government statisticians. To do this, a number of goods that are representative of the economy are put together into what is referred to as a "market basket." The cost of this basket is then compared over time. This results in a price index, which is the cost of the market basket today as a percentage of the cost of that identical basket in the starting year.
Consumer Price Index (CPI) - A measure of price changes in consumer goods and services such as gasoline, food, clothing and automobiles. The CPI measures price change from the perspective of the purchaser. U.S. CPI data can be found at the Bureau of Labor Statistics. Producer Price Indexes (PPI) - A family of indexes that measure the average change over time in selling prices by domestic producers of goods and services. PPIs measure price change from the perspective of the seller. U.S. PPI data can be found at the Bureau of Labor Statistics. Core price indices: because food and oil prices can change quickly due to changes in supply and demand conditions in the food and oil markets, it can be difficult to detect the long run trend in price levels when those prices are included. Therefore most statistical agencies also report a measure of 'core inflation', which removes the most volatile components (such as food and oil) from a broad price index like the CPI. Because core inflation is less affected by short run supply and demand conditions in specific markets, central banks rely on it to better measure the inflationary impact of current monetary policy. Cost-of-living indices (COLI) are indices similar to the CPI which are often used to adjust fixed incomes and contractual incomes to maintain the real value of those incomes. GDP deflator is a measure of the price of all the goods and services included in Gross Domestic Product (GDP). The US Commerce Department publishes a deflator series for US GDP, defined as its nominal GDP measure divided by its real GDP measure. Commodity price indices, which measure the price of a selection of commodities. In the present commodity price indices are weighted by the relative importance of the components to the "all in" cost of an employee.
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Regional inflation The Bureau of Labor Statistics breaks down CPI-U calculations down to different regions of the US. Asset price inflation is an undue increase in the prices of real or financial assets, such as stock (equity) and real estate. While there is no widely-accepted index of this type, some central bankers have suggested that it would be better to aim at stabilizing a wider general price level inflation measure that includes some asset prices, instead of stabilizing CPI or core inflation only. The reason is that by raising interest rates when stock prices or real estate prices rise, and lowering them when these asset prices fall, central banks might be more successful in avoiding bubbles and crashes in asset prices. Historical inflation Before collecting consistent econometric data became standard for governments, and for the purpose of comparing absolute, rather than relative standards of living, various economists have calculated imputed inflation figures. Most inflation data before the early 20th century is imputed based on the known costs of goods, rather than compiled at the time. It is also used to adjust for the differences in real standard of living for the presence of technology. Wholesale Price Index (WPI) WPI was first published in 1902, and was one of the more economic indicators available to policy makers until it was replaced by most developed countries by the Consumer Price Index in the 1970s. WPI is the index that is used to measure the change in the average price level of goods traded in wholesale market. In India, a total of 435 commodities data on price level is tracked through WPI which is an indicator of movement in prices of commodities in all trade and transactions. It is also the price index which is available on a weekly basis with the shortest possible time lag only two weeks. The Indian government has taken WPI as an indicator of the rate of inflation in the economy.
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Inflation in India:
Inflation in India statistics
Year 2010 2009 2008 2007 2006
Jan 16.22 10.45 5.51 6.72 4.39
Feb 9.63 5.47 7.56 5.31
Mar 8.03 7.87 6.72 5.31
Apr 8.70 7.81 6.67 5.26
May 8.63 7.75 6.61 6.14
Jun 9.29 7.69 5.69 7.89
Jul 11.89 8.33 6.45 6.90
Aug 11.72 9.02 7.26 5.98
Sep 11.64 9.77 6.40 6.84
Oct 11.49 10.45 5.51 7.63
Nov 13.51 10.45 5.51 6.72
Dec 14.97 9.70 5.51 6.72
We can clearly see that inflation in India is on a rise and The food index in January-February was almost constant. The food inflation was pegged at 17.81% towards February-end. Sugar prices rose to 55.47% in February whereas potato and pulses turned costlier by 30% and 35.58% respectively. Fuel inflation shot up to 12.68 per cent.
This is how food prices have risen since 2007: Food articles: 7.02% (in 2007) to 17.41% in January 2010. Food products: 3.43% (in 2007) to 22.55% in January 2010. Food commodities: 5.60% (in 2007) to 19.42% in January 2010. Foodgrains: 6.27% (in 2007) to 17.89% in January 2010.
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Cereals: 6.27% (in 2007) to 13.69% in January 2010. Pulses: 2.14% (in 2007) to 45.62% in 2007 in January 2010. Rice: 6.05% (in 2007) to 12.02% in January 2010. Wheat: 6.77% (in 2007) to 14.86% in January 2010. Dairy products: 6.08% (in 2007) to 12.87% in January 2010. Eggs, fish and meat: 6.38% (in 2007) to 30.71% in January 2010. Sugar: (-)14.69% (in 2007) to 58.94% in January 2010. Inflation in Food and Non-food Commodities during 1994-95 to January 2010 (Based on WPI with base 1993-94) and Growth Rate in Food Output (%) Item 1994-95 to 2005 2004-05 4.74 2006 2007 2008 2009 2010 Average January 2006-09 8.54 5.19
1. All 5.90 commodities 2. Non-food 6.02 commodities 3. Food 5.91 articles 4. Food 5.33 products 5. Food 5.64 commodities (3 and 4) Foodgrains Cereals Pulses
Rice Wheat Oilseeds Fruits and
4.82
4.82
9.12
2.01
5.37
4.72
4.54
9.55
-1.76
4.53
4.27
3.94
6.83
7.02
6.64
12.32 17.41
8.20
1.58
2.55
3.43
9.80
13.79 22.55
7.39
2.97
5.09
5.60
7.87
12.90 19.42
7.86
5.54 5.57 5.46
5.00 5.93 5.89 7.47
3.83 3.68 5.04
4.01 1.08 -6.11 7.51
9.71 6.63 32.05
2.13 12.99 -3.96 2.24
6.27 6.97 2.14
6.05 6.77 26.58 6.49
6.37 7.20 1.30
8.97 5.06 17.46 5.94
14.14 17.89 12.96 13.69 21.81 45.62
15.96 6.83 0.92 11.77 12.02 14.86 10.05 8.33
9.12 8.44 14.33
8.28 7.91 10.25 6.61
vegetables Dairy 5.20 0.11 4.20 6.08 8.38 6.12 12.87 6.19
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products Milk group Egg, fish and meat Edible oils Sugar 4.85 4.06 -7.19 15.09 1.23 4.83 13.11 14.69 Growth food (%/a year) in 2.39 0.55 5.87 4.10 5.39 1.60 -02 AE 4.24 12.52 5.62 -6.59 36.34 -1.17 58.94 5.07 8.02 5.57 6.46 0.73 9.46 4.48 6.72 8.17 6.38 7.87 3.75 8.93 14.44 13.99 30.71 7.36 7.82
output
Inflation in India is also a grave issue of concern, given the vast disparity between the rich and the poor on the one hand or the Rural and the Urban on the other. Skyrocketing inflation robs the poor, and hurts others, though much less grievously. The fruits of the much-talked about economic growth have not reached large sections, especially in the rural areas.
Inflation in other countries.
Inflation rates in BRIC countries
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Inflation in major countries
India comes in at almost as high as 16.22% Lowest Inflation for the quarter till march 2010 Countries New Zealand UK Australia EU Japan US Current Inflation (%) 3 2.9 2.5 0.6 -0.3 -0.4
India can learn some things from these countries as how to reduce the inflation levels.
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How to curb Inflation?
A variety of methods have been used in attempts to control inflation.
Gold standard The gold standard is a monetary system in which a region's common media of exchange are paper notes that are normally freely convertible into pre-set, fixed quantities of gold. The standard specifies how the gold backing would be implemented, including the amount of specie per currency unit. The currency itself has no innate value, but is accepted by traders because it can be redeemed for the equivalent specie. A U.S. silver certificate, for example, could be redeemed for an actual piece of silver. The gold standard was partially abandoned via the international adoption of the Bretton Woods System. Under this system all other major currencies were tied at fixed rates to the dollar, which itself was tied to gold at the rate of $35 per ounce. The Bretton Woods system broke down in 1971, causing most countries to switch to fiat money – money backed only by the laws of the country. Austrian economists strongly favor a return to a 100 percent gold standard. Under a gold standard, the long term rate of inflation (or deflation) would be determined by the growth rate of the supply of gold relative to total output. Critics argue that this will cause arbitrary fluctuations in the inflation rate, and that monetary policy would essentially be determined by gold mining, which some believe contributed to the Great Depression. Monetary policy Today the primary tool for controlling inflation is monetary policy. Most central banks are tasked with keeping the federal funds lending rate at a low level, normally to a target rate around 2% to 3% per annum, and within a targeted low inflation range, somewhere from about 2% to 6% per annum. A low positive inflation is usually targeted, as deflationary conditions are seen as dangerous for the health of the economy. There are a number of methods that have been suggested to control inflation. . High interest rates and slow growth of the money supply are the traditional ways through which central banks fight or prevent inflation, though they have different approaches. For instance, some follow asymmetrical inflation target while others only control inflation when it rises above a target, whether express or implied.
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Monetarists emphasize keeping the growth rate of money steady, and using monetary policy to control inflation (increasing interest rates, slowing the rise in the money supply). Keynesians emphasize reducing aggregate demand during economic expansions and increasing demand during recessions to keep inflation stable. Control of aggregate demand can be achieved using both monetary policy and fiscal policy (increased taxation or reduced government spending to reduce demand).
Fiscal Policies: Fiscal policies are effective in increasing the leakage rates from the circular income flow, thereby rejecting all further additions into this particular flow of income. This brings about a reduction in the Demand-Pull Inflation, in terms of increasing unemployment and slackening the economic growths. Following are a few types of fiscal policies commonly employed: Lowering the expenses on governmental level A fall in the borrowing amounts in the government sectors, on an annual basis High direct taxes, for reducing the disposable income
Fixed exchange rates Under a fixed exchange rate currency regime, a country's currency is tied in value to another single currency or to a basket of other currencies (or sometimes to another measure of value, such as gold). A fixed exchange rate is usually used to stabilize the value of a currency, vis-a-vis the currency it is pegged to. It can also be used as a means to control inflation. However, as the value of the reference currency rises and falls, so does the currency pegged to it. This essentially means that the inflation rate in the fixed exchange rate country is determined by the inflation rate of the country the currency is pegged to. In addition, a fixed exchange rate prevents a government from using domestic monetary policy in order to achieve macroeconomic stability. Wage and price controls Another method attempted in the past have been wage and price controls ("incomes policies"). Wage and price controls have been successful in wartime environments in combination with rationing. However, their use in other contexts is far more mixed. In general wage and price controls are regarded as a temporary and exceptional measure, only effective when coupled with policies designed to reduce the underlying causes of inflation during the wage and price control regime, for example, winning the war being fought. They often have perverse effects, due to the distorted signals they send to the market. Artificially low prices often
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cause rationing and shortages and discourage future investment, resulting in yet further shortages. The usual economic analysis is that any product or service that is under-priced is overconsumed. For example, if the official price of bread is too low, there will be too little bread at official prices, and too little investment in bread making by the market to satisfy future needs, thereby exacerbating the problem in the long term. Temporary controls may complement a recession as a way to fight inflation: the controls make the recession more efficient as a way to fight inflation (reducing the need to increase unemployment), while the recession prevents the kinds of distortions that controls cause when demand is high. However, in general the advice of economists is not to impose price controls but to liberalize prices by assuming that the economy will adjust and abandon unprofitable economic activity. The lower activity will place fewer demands on whatever commodities were driving inflation, whether labor or resources, and inflation will fall with total economic output. This often produces a severe recession, as productive capacity is reallocated and is thus often very unpopular with the people whose livelihoods are destroyed (see creative destruction).
Agriculture In the case of agriculture, if productivity rises to international levels, we will have a glut. Hence, for agriculture too, good management will prevent inflation. Thus, inflation can be attributed to poor management. In 1991, India embarked on an era of liberalisation. We can see resultant benefits in the phenomenal improvement in quality (and decrease in prices) in the liberalised sectors of the economy. Unfortunately, even as parts of the economy were liberalized Farm sector is riddled with restrictions.
Change in method to calculate inflation According to many experts India has been following an incorrect method or an old method to calculate inflation(WPI) there must be a change in it(CPI) so as to calculate the amount and take steps accordingly Cost-of-living allowance The real purchasing-power of fixed payments is eroded by inflation unless they are inflationadjusted to keep their real values constant. In many countries, employment contracts, pension benefits, and government entitlements (such as social security) are tied to a cost-of-living index, typically to the consumer price index. A cost-of-living allowance (COLA) adjusts salaries based on changes in a cost-of-living index. Salaries are typically adjusted annually. They may also be tied to a cost-of-living index that varies by geographic location if the employee moves.
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Annual escalation clauses in employment contracts can specify retroactive or future percentage increases in worker pay which are not tied to any index. These negotiated increases in pay are colloquially referred to as cost-of-living adjustments or cost-of-living increases because of their similarity to increases tied to externally-determined indexes. Many economists and compensation analysts consider the idea of predetermined future "cost of living increases" to be misleading for two reasons: (1) For most recent periods in the industrialized world, average wages have increased faster than most calculated cost-of-living indexes, reflecting the influence of rising productivity and worker bargaining power rather than simply living costs, and (2) most cost-of-living indexes are not forward-looking, but instead compare current or historical data. A stronger rupee A stronger rupee helps reduce inflation because it lowers the import prices of oil, other raw materials and capital goods and this, in turn, lowers the cost of production. It also reduces the prices of import-competing goods, like steel. A related myth is that a strong rupee will kill the economy by hurting exporters. A stronger rupee does reduce the rupee value of export earnings but it also reduces the cost of imported inputs, and to the extent that it dampens inflation, it limits the need for interest-rate hikes. Moreover, exporters are in a robust position now.
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Bibliography:
www.investopedia.com www.economy-watch.com www.india-reports.com www.tradechakra.com www.wikipedia.org www.rediff.com www.yahoofinance.com http://in.finance.yahoo.com http://tutor2u.net www.businessmapofindia.com www.tradingeconomics.com www.euromonitor.com www.indexmundi.com www.commodityonline.com www.reuters.com www.inflationdata.com
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