Description
the role of money in an economy, and the different aspects of demand and supply of money, to explore the realms of inflation and its different frontiers, to delve into concepts like wage price spiral, hyperinflation and inflationary gap to understand various measures of inflation
Money Supply and Inflation
?
? ? ?
?
To understand the role of money in an economy, and the different aspects of demand and supply of money. To explore the realms of inflation and its different frontiers. To delve into concepts like wage price spiral, hyperinflation and inflationary gap. To understand various measures of inflation and their role in decision making. To analyze the reasons behind inflation, its impact on the economy and the measures to curb it.
Money Concepts
?
?
Money is in demand because all the things which have utility to you are available in exchange for money. Medium of Exchange:
? the most convenient medium of exchange. ? Under barter system where goods (or services) are exchanged for goods (or services) dual coincidence of wants is the basis for exchange. ? Provides a common denominator to all types of goods and services. ? Can be saved for future with convenience, whereas other goods can be saved for a limited time period only.
?
Measure of Value: Store of Value:
?
?
Transaction Motive:
?
Precautionary Motive:
Speculative Motive:
? Consumers need money to meet their day to day needs, ? producers need money to make investments. ? To cover for unforeseen events such as sickness, accidents and losses, money is kept as precaution for contingency. ? For making gains from speculation on future value of bonds and securities.
?
Money may be demanded as a flow (transaction motive) as well as a stock (precautionary motive). Money as a flow is that which is in circulation. Total money supply at any point of time consists of money in circulation as well as in stock (in various forms of savings and deposits).
?
?
?
? ? ?
Modern form of money is simply pieces of paper or numbers in a ledger. Earlier money was in the form of coins, composed of gold, silver and copper ,etc. Value of the coins was based on the value of the metals they contained. System of paper money was introduced based on the gold standard or silver standard or some combination of the two, to ensure people?s faith in the system. The gold standard broke down in 1930 in UK, in USA it lasted till 1971 This piece of paper is just like a promissory note issued by a relevant authority. A currency issued by the government is called a fiduciary issue (based on trust and confidence).
?
?
?
India followed the proportional reserve system until 1956, whereby a reserve of gold, silver, government securities and foreign securities was maintained, of which gold and or foreign securities were at least 40% of total reserves. In 1956 this was replaced by fixed minimum reserve system in which reserve worth Rs. 400 crore including gold worth Rs. 115 crores was kept, which was reduced to Rs. 200 crore including gold worth Rs. 115 crores in 1957. Thus practically Indian currency is nonconvertible in any precious metal and is a fiat money that is declared by state to be a legal tender. Under this system any number of notes can be printed as per needs of the economy.
?
Narrow money includes only very liquid
?
assets like currency, i.e. notes and coins in the hands of public and demand deposits in the banks. Broad money includes a set of less liquid assets like term deposits with banks.
RBI calculates various concepts of money supply which are known as money supply aggregates or measures of monetary aggregates. M1: Currency with public, i.e. coins and notes + demand deposits of public with banks. It is also known as Narrow Money M2: M1 + Post office savings deposits M3: M2 + Time deposits of the public with banks+ “Other” deposits with Banks. It is also known as Broad Money. M4: M3 + All other deposits with Post office M0: Currency in circulation+ Bankers? deposits with RBI+ “Other” deposits with RBI. It is also called Reserve Money. Now RBI calculates only three of the above measures, i.e. M0, M1, and M3.
?
Monetization of economy is measured by the ratio of M1 to GDP
?
The monetary deepening is measured by ratio of M3 to GDP
? Has ncreased steadily during the period from 43.8 in 199091 to 71.3 in 2006-07.
? has shown an upward trend since 1990-91 but for minor deceleration during the period 1996-2000. ? In 1990-91 it was 15.3 which has grown to 20.7 due to faster expansion of currency with public. ? Velocity of money during 31-3-2006 to 31-3-2007 was 1.39.
The increase in inflationary pressures in the middle of 2006-07 has been attributed to the acceleration in M3 growth during 2006-07.
Inflation
?
Coulborn:
goods”.
it is a state of “too much money chasing too few
?
Two broad categories: ? price inflation ? money inflation. Both have cause and effect relationship, i.e. money inflation leads to price inflation.
currency on demand of the government to meet its needs. ? FDI and FII: Additional money supply through foreign exchange inflows in the form of capital, such as foreign direct investment and foreign institutional investment tourism and other incomes from abroad. Price inflation is a persistent increase in the general price level or a persistent decline in the real income of people.
Money inflation is increase in the amount of currency in circulation. ? Deficit financing : direct cause is printing of additional
?
Headline Inflation:
? measure of the total inflation within an economy ? affected by the areas of the market which may experience sudden inflationary spikes such as food or energy.
? Inflationary Spikes: occurs when a particular section of the economy experiences a sudden price rise, possibly due to external factors.
?
Hyperinflation:
? prices increase at such a speed that the value of money erodes drastically and the economy is trapped between rising prices and wages.
? This is also known as galloping inflation or runaway inflation.
?
Stagflation:
? a typical situation when stagnation and inflation coexist.
? India faced stagflation in the decade of 1970s, when industrial production was at its lowest, accompanied by mounting prices. ? Current situation if not controlled may result in stagflation.
?
Suppressed Inflation:
? when inflationary conditions exist, but the government makes such policies which temporarily keep prices under check
? as soon as these checks are removed, inflation bursts out.
?
Disinflation:
? a process of keeping a check on price rise by deliberate attempts. ? It is a well planned process to bring down prices moderately from a very high level.
?
Deflation:
? just opposite to inflation; ? a state when prices fall persistently.
?
?
Inflationary Gap represents rise in price due to a gap between effective demand and supply. The term was coined by Keynes to describe a situation when there is an „excess of
anticipated expenditure over available output at base prices?.
?
When money income in the hands of people exceeds the supply of goods and services, a gap is created between demand and supply resulting in inflation.
Wage Price Spiral
“Wages chase and prices chase wages” and create a wage price spiral.
•Workers attempt to protect their real wages by pushing for higher money (or nominal) wages.
Prices Rise Cost of production rises
Cost of living rises
Wages rise
?
Cost of higher education is soaring every year and the phenomenon is global.
? In USA the overall inflation rate since 1986 increased 92.32% in 2007, whereas, tuition increased a whopping 343.81%. ? As per an estimate the cost of attending state colleges will soar to $120,000 by 2015. ? A direct link can be found between tuition hikes and governmentbacked student loans without parent income restrictions started in 1992. ? Today the average undergraduate student loan debt is nearing $20,000.
? Those who go on to graduate school often end up with an additional $30,000. ? Law and medical students report an average accumulated debt from all years (undergraduate and graduate study) of $91,700.
?
This combination of high tuition and education loan created a tuition loan spiral.
?
?
Excess Money Supply:. Money supply is the most important cause of price rise, it can be directly linked with increase in aggregate demand. Demand Pull Inflation: when aggregate demand level increases due to any reason, and supply of output is unable to match this increased demand, the inflationary pressure thus built is known as demand pull inflation, i.e demand pulls prices up.
? ? ? ?
Increase in money supply Increase in disposable income Increase in aggregate spending Increase in population of the country
?
Cost Push Inflation: An increase in price of any of the inputs, will increase in the cost of production.
? Any inflationary pressure created i.e. prices pushed up by
cost.
?
Low Increase in Supply: if supply falls short of demand, prices will increase.
? ? ? ? ?
Obsolete technology Deficient machinery Scarcity of resources Natural calamities Industrial disputes and external aggressions
?
Built in Inflation: Built in inflation is a type of inflation that has resulted from past events and persists in the present. ? It is also known as hangover inflation.
?
?
“It is well recognized that inflation in India is a structural as well as a monetary phenomenon. In the short term, localized demand supply imbalances in wage goods, often due to seasonal variations in production coupled with market rigidities and regulatory failures have supported inflationary expectations that have resulted in a more widespread impact on the consumers than the initial inflationary
?
?
?
In the medium to long-term, the movement and outcome of monetary aggregates such as the money supply and reference interest rates of the financial systems have influenced aggregate demand and consequently changes in price levels in the economy. The latter considerations and the influence of global commodity prices on the domestic prices have become more important with the opening and growing integration of the Indian economy with the rest of the world. Indeed, the fiscal 2007-08 has demonstrated this facet of the economy more than ever before. With huge surge in capital inflows, the liquidity management with its underlying implications for inflation has been a major challenge for the policymakers.”
?
A price index is a numerical measure designed to help to compare how the prices of some class of goods and/or services, taken as a whole, differ between time periods or geographical locations. Prices of that base year are assumed to be equal to 100.
Current Year' s Price ? 100 Price Index = Base Year' s Price
?
?
Producer Price Index (PPI): measures average changes in prices received by domestic producers for their output. It measures the pressure being put on producers by the costs of their raw materials. Wholesale Price Index (WPI): measures on the basis of wholesale prices of a wide variety of goods (including consumer and capital goods. In India, WPI is available on a weekly basis, and is the most popular measure.
? USA has replaced WPI with PPI
?
Consumer Price Index (CPI): measures the price of a selection of goods purchased by a "typical consumer.“
? CPI differs from PPI in that price subsidization, profits, and taxes may cause the amount received by the producer to differ from what the consumer paid.
?
In India four types of Consumer Price Indices (CPls) are issued that are specific to different groups of consumers
? ? ? ? CPI-IW for industrial workers; CPI-UNME for urban non manual employees; CPI-AL for agricultural labourers; and, CPI-RL for rural labourers
?
?
CPI-IW is the most well known of these indices as it is used for wage indexation in Government and in the organized sectors Central Statistical Organization has initiated steps to compile CPI under two broad categories
? i. CPI (Rural) and ? ii. CPI (Urban).
?
?
Cost of Living Indices (COLI): these are used to adjust fixed incomes and contractual incomes to maintain the real value of such incomes. In fact wage indexation is based on such indices. Service Price Index (SPI): With the growing importance of service sector across the world, many countries have started developing services price indices (SPI).
Inflation Rate ? Last year's Index - Current Year' s Index ?100
Current Year' s Index
?
1942 Beginning of the process of compilation of prices and converting them into comparative indices
?
?
1947, the series included as many as 78 commodities, covering 215 individual quotations classified into five groups: food articles; industrial raw materials; semi-manufactures; manufactures; and miscellaneous. 1952-53 a new series was issued with 1952-53 as base price and 1948-49 as weight base consisting of 112 commodities and 555 quotations.
? published for the first time an index number of wholesale prices from the week commencing January 10, 1942, with base week ended August 19, 1939 = 100. ? The WPI was calculated as the geometric mean of the price relatives of 23 commodities.
? The commodities were reclassified into new set of five groups: food article; liquor & tobacco; fuel, power, light & lubricants; industrial raw materials; and manufactures. ? The weighted arithmetic average replaced the weighted geometric mean.
?
?
?
Since then the base year has changed four times and number of articles/commodities increased substantially. July 1969: A new series of WPI with base 1961-62 = 100 covering 139 commodities and 774 quotations. January 1977 a new series with wider coverage of items (360 commodities) and 1295 quotations and a new base year 1970-71.
? the commodities were divided into three major groups: i. primary articles; ii. fuel, power, light & lubricants; and iii. manufactured products. ? Weights were assigned on the basis of the entire wholesale transactions in the economy and the values of transactions of the non-selected commodities were assigned to selected commodities whose nature and price trends were similar.
?
1989:The WPI series underwent another restructuring with 1981-82 as the base year, 447 distinct commodities and 2,371 price quotations.
?
The latest WPI series with the new base year 199394 follows the same methodology as earlier however now there are altogether 435 articles/items in the new series, comprising of 98 'primary articles', 19 items of 'fuel, power, light and lubricants'; and 318 'manufactured products'.
? The method of compilation and assigning of weights, as well as the classification into three major groups continued.
2001-02 2002-03 WPI Inflation Rate % 161.3 3.6 166.8 3.5
2003-04 175.9 5.4
2004-05 187.3 6.4
2005-06 2006-07 195.6 4.4 105.0 5.0
Impact on Consumers:
? Consumer makes a tentative budget based on monthly (or weekly) income and expenses. ? increase in any price upsets the whole budget.
Impact on Producers (or Suppliers):
? Producers are benefited by inflation; ? higher the prices, higher are their profits.
But
? when they have to buy raw material, hire workforce, buy technology or machine, they are adversely affected by inflation.
Impact on Government:
? Government takes responsibility to take care of the interest of all the sections of the society. ? At one end it is committed to take the economy to higher levels of growth by encouraging production and investment, ? At the other end, the government is duty bound to see that taxpayers? money is not eroded by hyperinflation. ? Thus government has to act as the balancing force between consumers and sellers.
Inflation and Employment
•A. W. H. Philips studied the relationship between unemployment and rate of changes in money wages in UK, taking statistics for a period spanning almost a century from 1862 to 1957. •Philips postulated that the lower the rate of unemployment, the higher is the rate of change of wages.
•labours accept jobs at lower pay if they are unemployed and firms are more willing to hire due to low wages. •But this effect dissipates as inflation becomes more expected with workers demanding higher wages and firms being less willing to hire. •therefore the objectives of low unemployment and low rate of inflation may be inconsistent.
•Hence the government must choose between the feasible combinations of unemployment and inflation
? P/P
?W/W 10 8
8
Annual Price Rise %
6 4 2
O
Philips’ curve
2 4 6
Annual Wage 6 Rise %
4
8
Unemploymen t %
2 1
? ?
Demand pull inflation refers to the effects of falling unemployment rates (rising real national income) in the curve. Cost push inflation and built in inflation will lead to shifts in the Phillips curve.
? ? ?
Inflation erodes the value of money and discourages savings But zero inflation is undesirable Need to control inflation
? monetary policy measures (proposed by those who believed money supply is the major culprit) ? fiscal policy measures (proposed by Keynes and his followers).
?
?
Excessive money supply may bring about inflation, therefore to control inflation it is necessary that a curb is put on money supply. The central bank of the country uses various methods of credit control to keep a check on inflation. ? Increasing the discount rate: The central bank rediscounts the eligible papers offered by commercial banks. This is also called bank rate ? Higher reserve ratios: ? Cash Reserve Ratio (CRR) and ? Statutory Liquid Ratio (SLR) ? Open market operations: Central bank may directly sell government securities to general public and thus restrain their disposable income ? Selective credit control: discourages consumption but not investment
?
The government may reduce public expenditure or increase public revenue to keep a check on inflation
? Reducing public expenditure
? When government spends on activities like health, transport, communication, etc., income of individuals increases; this in turn increases the aggregate demand. ? Therefore the reverse will also be true. ? Major source of government revenue is various types of taxes ? Increase in income tax leaves less of disposable income in the hands of consumers
? Increasing public revenue
Monetary and Fiscal measures hit the demand side and ignore the supply side of prices Increasing Supply
? increase imports and decrease exports of the items which are short in supply. ? Public distribution system, ? administered pricing of essential commodity groups ? Economic Survey 2007-08 states that government has decided to maintain price stability of food grains, reduction in import duties and custom duties on edible oils and other oils and ban on export of wheat and pulses.
The government has to adopt an appropriate combination of these measures after thorough examination of the causes of inflation.
? ? ?
It is automatic linkage between monetary obligations and price levels. Indexation reduces the cost of inflation. Applies to wages, interest and taxes
? employers are forced to index wages against prices so that the gap between money income and real income may be minimized. ? Interest of long term loans is so determined that the borrower would have to pay the loan in real terms. ? For example
? National Savings Certificates are index linked. ? The purchasing power parity theory of exchange rate determination in international economics is an example of indexation
?
Would implementation of recommendations of the Sixth Pay Commission of India increase inflation? Why is it so that term „inflation? has become synonymous with price inflation and not money inflation? If zero inflation is bad why would a government try to control inflation? What are the motives behind holding money?
?
?
?
doc_945864167.pptx
the role of money in an economy, and the different aspects of demand and supply of money, to explore the realms of inflation and its different frontiers, to delve into concepts like wage price spiral, hyperinflation and inflationary gap to understand various measures of inflation
Money Supply and Inflation
?
? ? ?
?
To understand the role of money in an economy, and the different aspects of demand and supply of money. To explore the realms of inflation and its different frontiers. To delve into concepts like wage price spiral, hyperinflation and inflationary gap. To understand various measures of inflation and their role in decision making. To analyze the reasons behind inflation, its impact on the economy and the measures to curb it.
Money Concepts
?
?
Money is in demand because all the things which have utility to you are available in exchange for money. Medium of Exchange:
? the most convenient medium of exchange. ? Under barter system where goods (or services) are exchanged for goods (or services) dual coincidence of wants is the basis for exchange. ? Provides a common denominator to all types of goods and services. ? Can be saved for future with convenience, whereas other goods can be saved for a limited time period only.
?
Measure of Value: Store of Value:
?
?
Transaction Motive:
?
Precautionary Motive:
Speculative Motive:
? Consumers need money to meet their day to day needs, ? producers need money to make investments. ? To cover for unforeseen events such as sickness, accidents and losses, money is kept as precaution for contingency. ? For making gains from speculation on future value of bonds and securities.
?
Money may be demanded as a flow (transaction motive) as well as a stock (precautionary motive). Money as a flow is that which is in circulation. Total money supply at any point of time consists of money in circulation as well as in stock (in various forms of savings and deposits).
?
?
?
? ? ?
Modern form of money is simply pieces of paper or numbers in a ledger. Earlier money was in the form of coins, composed of gold, silver and copper ,etc. Value of the coins was based on the value of the metals they contained. System of paper money was introduced based on the gold standard or silver standard or some combination of the two, to ensure people?s faith in the system. The gold standard broke down in 1930 in UK, in USA it lasted till 1971 This piece of paper is just like a promissory note issued by a relevant authority. A currency issued by the government is called a fiduciary issue (based on trust and confidence).
?
?
?
India followed the proportional reserve system until 1956, whereby a reserve of gold, silver, government securities and foreign securities was maintained, of which gold and or foreign securities were at least 40% of total reserves. In 1956 this was replaced by fixed minimum reserve system in which reserve worth Rs. 400 crore including gold worth Rs. 115 crores was kept, which was reduced to Rs. 200 crore including gold worth Rs. 115 crores in 1957. Thus practically Indian currency is nonconvertible in any precious metal and is a fiat money that is declared by state to be a legal tender. Under this system any number of notes can be printed as per needs of the economy.
?
Narrow money includes only very liquid
?
assets like currency, i.e. notes and coins in the hands of public and demand deposits in the banks. Broad money includes a set of less liquid assets like term deposits with banks.
RBI calculates various concepts of money supply which are known as money supply aggregates or measures of monetary aggregates. M1: Currency with public, i.e. coins and notes + demand deposits of public with banks. It is also known as Narrow Money M2: M1 + Post office savings deposits M3: M2 + Time deposits of the public with banks+ “Other” deposits with Banks. It is also known as Broad Money. M4: M3 + All other deposits with Post office M0: Currency in circulation+ Bankers? deposits with RBI+ “Other” deposits with RBI. It is also called Reserve Money. Now RBI calculates only three of the above measures, i.e. M0, M1, and M3.
?
Monetization of economy is measured by the ratio of M1 to GDP
?
The monetary deepening is measured by ratio of M3 to GDP
? Has ncreased steadily during the period from 43.8 in 199091 to 71.3 in 2006-07.
? has shown an upward trend since 1990-91 but for minor deceleration during the period 1996-2000. ? In 1990-91 it was 15.3 which has grown to 20.7 due to faster expansion of currency with public. ? Velocity of money during 31-3-2006 to 31-3-2007 was 1.39.
The increase in inflationary pressures in the middle of 2006-07 has been attributed to the acceleration in M3 growth during 2006-07.
Inflation
?
Coulborn:
goods”.
it is a state of “too much money chasing too few
?
Two broad categories: ? price inflation ? money inflation. Both have cause and effect relationship, i.e. money inflation leads to price inflation.
currency on demand of the government to meet its needs. ? FDI and FII: Additional money supply through foreign exchange inflows in the form of capital, such as foreign direct investment and foreign institutional investment tourism and other incomes from abroad. Price inflation is a persistent increase in the general price level or a persistent decline in the real income of people.
Money inflation is increase in the amount of currency in circulation. ? Deficit financing : direct cause is printing of additional
?
Headline Inflation:
? measure of the total inflation within an economy ? affected by the areas of the market which may experience sudden inflationary spikes such as food or energy.
? Inflationary Spikes: occurs when a particular section of the economy experiences a sudden price rise, possibly due to external factors.
?
Hyperinflation:
? prices increase at such a speed that the value of money erodes drastically and the economy is trapped between rising prices and wages.
? This is also known as galloping inflation or runaway inflation.
?
Stagflation:
? a typical situation when stagnation and inflation coexist.
? India faced stagflation in the decade of 1970s, when industrial production was at its lowest, accompanied by mounting prices. ? Current situation if not controlled may result in stagflation.
?
Suppressed Inflation:
? when inflationary conditions exist, but the government makes such policies which temporarily keep prices under check
? as soon as these checks are removed, inflation bursts out.
?
Disinflation:
? a process of keeping a check on price rise by deliberate attempts. ? It is a well planned process to bring down prices moderately from a very high level.
?
Deflation:
? just opposite to inflation; ? a state when prices fall persistently.
?
?
Inflationary Gap represents rise in price due to a gap between effective demand and supply. The term was coined by Keynes to describe a situation when there is an „excess of
anticipated expenditure over available output at base prices?.
?
When money income in the hands of people exceeds the supply of goods and services, a gap is created between demand and supply resulting in inflation.
Wage Price Spiral
“Wages chase and prices chase wages” and create a wage price spiral.
•Workers attempt to protect their real wages by pushing for higher money (or nominal) wages.
Prices Rise Cost of production rises
Cost of living rises
Wages rise
?
Cost of higher education is soaring every year and the phenomenon is global.
? In USA the overall inflation rate since 1986 increased 92.32% in 2007, whereas, tuition increased a whopping 343.81%. ? As per an estimate the cost of attending state colleges will soar to $120,000 by 2015. ? A direct link can be found between tuition hikes and governmentbacked student loans without parent income restrictions started in 1992. ? Today the average undergraduate student loan debt is nearing $20,000.
? Those who go on to graduate school often end up with an additional $30,000. ? Law and medical students report an average accumulated debt from all years (undergraduate and graduate study) of $91,700.
?
This combination of high tuition and education loan created a tuition loan spiral.
?
?
Excess Money Supply:. Money supply is the most important cause of price rise, it can be directly linked with increase in aggregate demand. Demand Pull Inflation: when aggregate demand level increases due to any reason, and supply of output is unable to match this increased demand, the inflationary pressure thus built is known as demand pull inflation, i.e demand pulls prices up.
? ? ? ?
Increase in money supply Increase in disposable income Increase in aggregate spending Increase in population of the country
?
Cost Push Inflation: An increase in price of any of the inputs, will increase in the cost of production.
? Any inflationary pressure created i.e. prices pushed up by
cost.
?
Low Increase in Supply: if supply falls short of demand, prices will increase.
? ? ? ? ?
Obsolete technology Deficient machinery Scarcity of resources Natural calamities Industrial disputes and external aggressions
?
Built in Inflation: Built in inflation is a type of inflation that has resulted from past events and persists in the present. ? It is also known as hangover inflation.
?
?
“It is well recognized that inflation in India is a structural as well as a monetary phenomenon. In the short term, localized demand supply imbalances in wage goods, often due to seasonal variations in production coupled with market rigidities and regulatory failures have supported inflationary expectations that have resulted in a more widespread impact on the consumers than the initial inflationary
?
?
?
In the medium to long-term, the movement and outcome of monetary aggregates such as the money supply and reference interest rates of the financial systems have influenced aggregate demand and consequently changes in price levels in the economy. The latter considerations and the influence of global commodity prices on the domestic prices have become more important with the opening and growing integration of the Indian economy with the rest of the world. Indeed, the fiscal 2007-08 has demonstrated this facet of the economy more than ever before. With huge surge in capital inflows, the liquidity management with its underlying implications for inflation has been a major challenge for the policymakers.”
?
A price index is a numerical measure designed to help to compare how the prices of some class of goods and/or services, taken as a whole, differ between time periods or geographical locations. Prices of that base year are assumed to be equal to 100.
Current Year' s Price ? 100 Price Index = Base Year' s Price
?
?
Producer Price Index (PPI): measures average changes in prices received by domestic producers for their output. It measures the pressure being put on producers by the costs of their raw materials. Wholesale Price Index (WPI): measures on the basis of wholesale prices of a wide variety of goods (including consumer and capital goods. In India, WPI is available on a weekly basis, and is the most popular measure.
? USA has replaced WPI with PPI
?
Consumer Price Index (CPI): measures the price of a selection of goods purchased by a "typical consumer.“
? CPI differs from PPI in that price subsidization, profits, and taxes may cause the amount received by the producer to differ from what the consumer paid.
?
In India four types of Consumer Price Indices (CPls) are issued that are specific to different groups of consumers
? ? ? ? CPI-IW for industrial workers; CPI-UNME for urban non manual employees; CPI-AL for agricultural labourers; and, CPI-RL for rural labourers
?
?
CPI-IW is the most well known of these indices as it is used for wage indexation in Government and in the organized sectors Central Statistical Organization has initiated steps to compile CPI under two broad categories
? i. CPI (Rural) and ? ii. CPI (Urban).
?
?
Cost of Living Indices (COLI): these are used to adjust fixed incomes and contractual incomes to maintain the real value of such incomes. In fact wage indexation is based on such indices. Service Price Index (SPI): With the growing importance of service sector across the world, many countries have started developing services price indices (SPI).
Inflation Rate ? Last year's Index - Current Year' s Index ?100
Current Year' s Index
?
1942 Beginning of the process of compilation of prices and converting them into comparative indices
?
?
1947, the series included as many as 78 commodities, covering 215 individual quotations classified into five groups: food articles; industrial raw materials; semi-manufactures; manufactures; and miscellaneous. 1952-53 a new series was issued with 1952-53 as base price and 1948-49 as weight base consisting of 112 commodities and 555 quotations.
? published for the first time an index number of wholesale prices from the week commencing January 10, 1942, with base week ended August 19, 1939 = 100. ? The WPI was calculated as the geometric mean of the price relatives of 23 commodities.
? The commodities were reclassified into new set of five groups: food article; liquor & tobacco; fuel, power, light & lubricants; industrial raw materials; and manufactures. ? The weighted arithmetic average replaced the weighted geometric mean.
?
?
?
Since then the base year has changed four times and number of articles/commodities increased substantially. July 1969: A new series of WPI with base 1961-62 = 100 covering 139 commodities and 774 quotations. January 1977 a new series with wider coverage of items (360 commodities) and 1295 quotations and a new base year 1970-71.
? the commodities were divided into three major groups: i. primary articles; ii. fuel, power, light & lubricants; and iii. manufactured products. ? Weights were assigned on the basis of the entire wholesale transactions in the economy and the values of transactions of the non-selected commodities were assigned to selected commodities whose nature and price trends were similar.
?
1989:The WPI series underwent another restructuring with 1981-82 as the base year, 447 distinct commodities and 2,371 price quotations.
?
The latest WPI series with the new base year 199394 follows the same methodology as earlier however now there are altogether 435 articles/items in the new series, comprising of 98 'primary articles', 19 items of 'fuel, power, light and lubricants'; and 318 'manufactured products'.
? The method of compilation and assigning of weights, as well as the classification into three major groups continued.
2001-02 2002-03 WPI Inflation Rate % 161.3 3.6 166.8 3.5
2003-04 175.9 5.4
2004-05 187.3 6.4
2005-06 2006-07 195.6 4.4 105.0 5.0
Impact on Consumers:
? Consumer makes a tentative budget based on monthly (or weekly) income and expenses. ? increase in any price upsets the whole budget.
Impact on Producers (or Suppliers):
? Producers are benefited by inflation; ? higher the prices, higher are their profits.
But
? when they have to buy raw material, hire workforce, buy technology or machine, they are adversely affected by inflation.
Impact on Government:
? Government takes responsibility to take care of the interest of all the sections of the society. ? At one end it is committed to take the economy to higher levels of growth by encouraging production and investment, ? At the other end, the government is duty bound to see that taxpayers? money is not eroded by hyperinflation. ? Thus government has to act as the balancing force between consumers and sellers.
Inflation and Employment
•A. W. H. Philips studied the relationship between unemployment and rate of changes in money wages in UK, taking statistics for a period spanning almost a century from 1862 to 1957. •Philips postulated that the lower the rate of unemployment, the higher is the rate of change of wages.
•labours accept jobs at lower pay if they are unemployed and firms are more willing to hire due to low wages. •But this effect dissipates as inflation becomes more expected with workers demanding higher wages and firms being less willing to hire. •therefore the objectives of low unemployment and low rate of inflation may be inconsistent.
•Hence the government must choose between the feasible combinations of unemployment and inflation
? P/P
?W/W 10 8
8
Annual Price Rise %
6 4 2
O
Philips’ curve
2 4 6
Annual Wage 6 Rise %
4
8
Unemploymen t %
2 1
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Demand pull inflation refers to the effects of falling unemployment rates (rising real national income) in the curve. Cost push inflation and built in inflation will lead to shifts in the Phillips curve.
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Inflation erodes the value of money and discourages savings But zero inflation is undesirable Need to control inflation
? monetary policy measures (proposed by those who believed money supply is the major culprit) ? fiscal policy measures (proposed by Keynes and his followers).
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Excessive money supply may bring about inflation, therefore to control inflation it is necessary that a curb is put on money supply. The central bank of the country uses various methods of credit control to keep a check on inflation. ? Increasing the discount rate: The central bank rediscounts the eligible papers offered by commercial banks. This is also called bank rate ? Higher reserve ratios: ? Cash Reserve Ratio (CRR) and ? Statutory Liquid Ratio (SLR) ? Open market operations: Central bank may directly sell government securities to general public and thus restrain their disposable income ? Selective credit control: discourages consumption but not investment
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The government may reduce public expenditure or increase public revenue to keep a check on inflation
? Reducing public expenditure
? When government spends on activities like health, transport, communication, etc., income of individuals increases; this in turn increases the aggregate demand. ? Therefore the reverse will also be true. ? Major source of government revenue is various types of taxes ? Increase in income tax leaves less of disposable income in the hands of consumers
? Increasing public revenue
Monetary and Fiscal measures hit the demand side and ignore the supply side of prices Increasing Supply
? increase imports and decrease exports of the items which are short in supply. ? Public distribution system, ? administered pricing of essential commodity groups ? Economic Survey 2007-08 states that government has decided to maintain price stability of food grains, reduction in import duties and custom duties on edible oils and other oils and ban on export of wheat and pulses.
The government has to adopt an appropriate combination of these measures after thorough examination of the causes of inflation.
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It is automatic linkage between monetary obligations and price levels. Indexation reduces the cost of inflation. Applies to wages, interest and taxes
? employers are forced to index wages against prices so that the gap between money income and real income may be minimized. ? Interest of long term loans is so determined that the borrower would have to pay the loan in real terms. ? For example
? National Savings Certificates are index linked. ? The purchasing power parity theory of exchange rate determination in international economics is an example of indexation
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Would implementation of recommendations of the Sixth Pay Commission of India increase inflation? Why is it so that term „inflation? has become synonymous with price inflation and not money inflation? If zero inflation is bad why would a government try to control inflation? What are the motives behind holding money?
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doc_945864167.pptx