Description
The presentation includes all the basics you need to know of inflation.
Inflation
S
Mystique of Inflation
Once an old couple was having a discussion over breakfast. Irritated over her husband’s remarks about past things and events, she complained, “You are always living in the past!”
Prompt came the reply. “It’s a lot cheaper dear!”
Inflation: The rate at which the general level of prices for goods and services is rising, and, subsequently, purchasing power is falling. As inflation rises, every rupee will buy a smaller percentage of a good. For example, if the inflation rate is 2%, then Rs.10 pack of gum will cost Rs.10.20/- in a year. Most countries' central banks will try to sustain an inflation rate of 2-3%. In India, RBI views the ideal rate to be around 3-5%.
Certain Concepts
S
Core Inflation A measure of inflation that excludes certain items, which face volatile price movements. Core Inflation is thought to be an indicator of underlying long-term inflation. Core inflation is most often calculated by excluding certain items from the index, usually fuel and food products.
S
Price Inflation An increase in the price of a standardized good/service or a basket of goods/services over a specific period of time (usually one year). Because the nominal amount of money available in an economy tends to grow larger every year relative to the supply of goods available for purchase, this overall demand pull tends to cause some degree of price inflation. Price inflation can also be seen in a slightly different form, where the price of a good is the same year over year, but the amount of the good received gradually decreases. E.g. chips, chocolates etc.
Hyperinflation Hyperinflation is a situation where the price increases are so out of control that the concept of inflation is meaningless. A working definition is that a country is in hyperinflation when its annual inflation rate reaches 1000% p.a. Depressions - Hyperinflation often occurs when there is a large increase in the money supply not supported by gross domestic product (GDP) growth, resulting in an imbalance in the supply and demand for the money. Left unchecked this causes prices to increase, as the currency loses its value. Wars - Hyperinflation often occurs when there is a loss of confidence in a currency's ability to maintain its value in the aftermath. Because of this, sellers demand a risk premium to accept the currency, and they do this
How is Inflation Measured?
S Inflation is measured as the percentage rate of change of
a price index over a particular period of time, normally a year.
S Therefore, if inflation for a particular week is say 7%, it
means the index is 7% higher, than it was in the same week during the previous year.
S The two most important price indices in India are the
Consumer Price Index (CPI) and the Wholesale Price Index (WPI). The WPI is India’s most watched cost monitor. Most developed countries use the CPI as an index over the WPI.
How is Inflation Measured?
S Wholesale Price Index (WPI)
WPI is the index that is used to measure the change in the average price level of goods traded in wholesale market. The WPI is based on 435 items, which come under three categories: S Primary Articles – 22.02% S Fuel, Power, Light & Lubricants – 14.23% S Manufactured Products – 63.75% This price index 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.
How is Inflation Measured?
S Consumer Price Index
CPI is a statistical time-series measure of a weighted average of prices of a specified set of goods and services purchased by consumers. It is a price index that tracks the prices of a specified basket of consumer goods and services, providing a measure of inflation. CPI is a fixed quantity price index and considered by some a cost of living index. This index is calculated on a monthly basis. Most countries use the CPI as a measure of inflation, as this actually measures the increase in price that a consumer will ultimately have to pay for.
S Inflation occurs when most
Why does Inflation Occur?
The main reasons :
• Cost Push Inflation • Demand Pull Inflation
prices are rising by some degree across the whole economy. This is caused by four possible factors, each of which is related to basic economic principles of changes in supply and demand: 1. Increase in the money supply. 2. Decrease in the demand for money. 3. Decrease in the aggregate supply of goods and services. 4. Increase in the aggregate demand for goods and services.
Cost Push Inflation
S Cost-push inflation basically means that prices have been
“pushed up” by increases in costs of any of the four factors of production (labor, capital, land or entrepreneurship) when companies are already running at full production capacity.
S With higher production costs and productivity maximized,
companies cannot maintain profit margins by producing the same amounts of goods and services. As a result, the increased costs are passed on to consumers, causing a rise in the general price level (inflation).
• When the price of factors of
production increase, the costs of production increase.
• As production costs
Cost Push Inflation
increase, aggregate supply decreases from AS1 to AS2 (given production is at full capacity), causing an increase in the price level from P1 to P2. The rationale behind this increase is that, for companies to maintain (or increase) profit margins, they will need to raise the retail price paid by consumers, thereby causing inflation.
Demand Pull Inflation
S Demand-pull inflation occurs when there is an increase in
aggregate demand, categorized by the four sections of the macro economy: households, businesses, governments and foreign buyers.
S When these four sectors concurrently want to purchase more
output than the economy can produce, they compete to purchase limited amounts of goods and services. Buyers in essence “bid prices up”, again, causing inflation.
S This excessive demand, also referred to as “too much money
chasing too few goods”, usually occurs in an expanding economy.
• When aggregate demand increases
without a change in aggregate supply, the „quantity supplied? will increase (given production is not at full capacity).
• If aggregate demand increases
Demand Pull Inflation
from AD1 to AD2, in the short run, this will not change (shift) aggregate supply, but cause a change in the quantity supplied as represented by a movement along the AS curve. The rationale behind this lack of shift in aggregate supply is that aggregate demand tends to react faster to changes in economic conditions than aggregate supply.
• As companies increase production
due to increased demand, the cost to produce each additional output increases, as represented by the change from P1 to P2. Demand-pull inflation can occur as companies, to maintain profit levels, pass on the higher cost of production to
Phillips Curve
• The Phillips Curve was
Inflation
developed in 1958 by A.W. Phillips, a professor in LSE.
• This curve depicts an inverse
i2 i* i1
relationship between the rate of unemployment and the rate of increase in the money wages.
• Higher the unemployment
lower is the rate of wage inflation and vice versa.
• This situation occurs in the
U2
U*
U1
Unemployment
case of demand induced inflation.
Stagflation
Inflation
A situation where a positive relation between unemployment and inflation exits. Stagflation is characterized by high growth of price level accompanied by economic stagnation caused primarily due to high levels of unemployment. This situation occurs when inflation is supply induced as it is not profitable for the producer to produce more so they lay workers off. Thus inflation here causes economic stagnation.
i1 i*
U*
U1
Unemploymen t
NAIRU
• Non Accelerating Inflation
Rate of Unemployment.
• The NAIRU is the lowest
unemployment rate that can be sustained without sustained upward pressure on inflation.
•It is a situation where the
demand and supply induced inflation cancel out each other?s effects such that variables are unchanged.
Costs of Inflation
• Creditors lose and debtors gain if the lender
does not anticipate inflation correctly. For those who borrow, this is similar to getting an interest-free loan.
•Uncertainty about what will happen next
makes corporations and consumers less likely to spend. This hurts economic output in the long run.
•People living off a fixed-income, such as
retirees, see a decline in their purchasing power and, consequently, their standard of living.
• The entire economy must absorb re-pricing
costs ("menu costs") as price lists, labels, menus and more have to be updated.
• If the inflation rate is greater than that of
other countries, domestic products become less competitive.
The question shouldn't be whether inflation is
10 Nations with Highest Inflation
Country Serbia Afghanistan Democratic Republic of Congo Inflation 15.5% 17% 18.2%
Uzbekistan Myanmar
Yemen San Tome & Principe Guinea Iraq Zimbabwe
19.2% 20%
20.8% 23.1% 30.9% 53.2% 355,000% (Hyperinflation)
Causes of Inflation
Global?
“Inflation is everywhere and always a monetary phenomenon”
-Milton Friedman
Indian Inflation
S
Rising Economies
S Exporters of Deflation S
Low Cost Production
S
S S
Cheap Labor
Resource Availability
Creators of Inflation
S S
Second moment of Demand Rising Wages
S Phillips Curve S Currency Appreciation
Exporting Inflation?
Inflation in Rising Economies
Oil Crises
?The 2004 shift
?Instability in Russia
?North Sea and Mexico
deposits declining
?Lower OPEC production
?Insatiable demand of
Asia
Global Output Gap
The SubPrime Effect
?Wiped out approximately $450
billion
?Fed and ECB injected around
$300 billion
?Excess liquidity ?Creation of investment opportunity
?Lack of Investment option in
US/Euro Area
?Led to speculative movement
Could Speculation be the reason?
Food Crises
?Lower harvest worldwide ?Crop damage ?Bio-fuels ?Rising population
Indian Imports
Sr. No. 1 2 3 4
Commodity Fuel, Power, Coal Sugar Edible Oil Fertilizers
Weightage 14.2 3.6 2.8 3.7
5
Iron & Steel
3.6
The Mechanics of Inflation and its Impact
1
Inflation Poor as fixed wage workers: Constt. Income Lesser no. of goods purchased for the same money Disparity increase Rich are mostly businessmen Benefit of increased money goes to the rich.
Import?? Export??
2
Inflation Domestic goods are expensive Foreign goods are cheaper
Exports hit
Imports favored
Trade deficit
3
Interest rate differential Inflation Forex Inflows(More dollars)
Increase demand
Rupee Appreciation
Increased money supply Intervention by govt. to curb appreciation.
Exporters hit
EXCHANGE RATES???
DEBT MARKET
4
22000 20000
EQUITY MARKET
Sensex (2008)
18000
16000 14000 12000 10000 01/08
02/08
03/08
04/08
05/08
06/08
07/
Major losers: elderly people and pensioners
Major losers: Corporate, Retail Investors
Returns in the markets
5
RETAIL SEGMENTA COMMA TO CONSUMERISM??
6
Impact Inflation: Corporate India under pressure
Year-on-year growth in input costs, interest rate and rising bills for power, fuel, salaries and wages are eating into their margins. Beyond a certain level the sale price (in every sector) cannot be increased
6? in Stagflation India ?
Simultaneous with rising inflation, growth indicators are deteriorating (reflected in the May IIP numbers). Expect monetary tightening in July to be nuanced rather than aggressive.
Public Policy Measures
S
Policy Measures
Fiscal Monetary
Taxation Excise duty Future Trade Export policy Subsidies
CRR SLR Interest rate MSS REPO REVERSE REPO
Long Term solutions
Productivity
Natural and renewable resources
Rationing and public transport
Thank You
S
doc_298435639.pptx
The presentation includes all the basics you need to know of inflation.
Inflation
S
Mystique of Inflation
Once an old couple was having a discussion over breakfast. Irritated over her husband’s remarks about past things and events, she complained, “You are always living in the past!”
Prompt came the reply. “It’s a lot cheaper dear!”
Inflation: The rate at which the general level of prices for goods and services is rising, and, subsequently, purchasing power is falling. As inflation rises, every rupee will buy a smaller percentage of a good. For example, if the inflation rate is 2%, then Rs.10 pack of gum will cost Rs.10.20/- in a year. Most countries' central banks will try to sustain an inflation rate of 2-3%. In India, RBI views the ideal rate to be around 3-5%.
Certain Concepts
S
Core Inflation A measure of inflation that excludes certain items, which face volatile price movements. Core Inflation is thought to be an indicator of underlying long-term inflation. Core inflation is most often calculated by excluding certain items from the index, usually fuel and food products.
S
Price Inflation An increase in the price of a standardized good/service or a basket of goods/services over a specific period of time (usually one year). Because the nominal amount of money available in an economy tends to grow larger every year relative to the supply of goods available for purchase, this overall demand pull tends to cause some degree of price inflation. Price inflation can also be seen in a slightly different form, where the price of a good is the same year over year, but the amount of the good received gradually decreases. E.g. chips, chocolates etc.
Hyperinflation Hyperinflation is a situation where the price increases are so out of control that the concept of inflation is meaningless. A working definition is that a country is in hyperinflation when its annual inflation rate reaches 1000% p.a. Depressions - Hyperinflation often occurs when there is a large increase in the money supply not supported by gross domestic product (GDP) growth, resulting in an imbalance in the supply and demand for the money. Left unchecked this causes prices to increase, as the currency loses its value. Wars - Hyperinflation often occurs when there is a loss of confidence in a currency's ability to maintain its value in the aftermath. Because of this, sellers demand a risk premium to accept the currency, and they do this
How is Inflation Measured?
S Inflation is measured as the percentage rate of change of
a price index over a particular period of time, normally a year.
S Therefore, if inflation for a particular week is say 7%, it
means the index is 7% higher, than it was in the same week during the previous year.
S The two most important price indices in India are the
Consumer Price Index (CPI) and the Wholesale Price Index (WPI). The WPI is India’s most watched cost monitor. Most developed countries use the CPI as an index over the WPI.
How is Inflation Measured?
S Wholesale Price Index (WPI)
WPI is the index that is used to measure the change in the average price level of goods traded in wholesale market. The WPI is based on 435 items, which come under three categories: S Primary Articles – 22.02% S Fuel, Power, Light & Lubricants – 14.23% S Manufactured Products – 63.75% This price index 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.
How is Inflation Measured?
S Consumer Price Index
CPI is a statistical time-series measure of a weighted average of prices of a specified set of goods and services purchased by consumers. It is a price index that tracks the prices of a specified basket of consumer goods and services, providing a measure of inflation. CPI is a fixed quantity price index and considered by some a cost of living index. This index is calculated on a monthly basis. Most countries use the CPI as a measure of inflation, as this actually measures the increase in price that a consumer will ultimately have to pay for.
S Inflation occurs when most
Why does Inflation Occur?
The main reasons :
• Cost Push Inflation • Demand Pull Inflation
prices are rising by some degree across the whole economy. This is caused by four possible factors, each of which is related to basic economic principles of changes in supply and demand: 1. Increase in the money supply. 2. Decrease in the demand for money. 3. Decrease in the aggregate supply of goods and services. 4. Increase in the aggregate demand for goods and services.
Cost Push Inflation
S Cost-push inflation basically means that prices have been
“pushed up” by increases in costs of any of the four factors of production (labor, capital, land or entrepreneurship) when companies are already running at full production capacity.
S With higher production costs and productivity maximized,
companies cannot maintain profit margins by producing the same amounts of goods and services. As a result, the increased costs are passed on to consumers, causing a rise in the general price level (inflation).
• When the price of factors of
production increase, the costs of production increase.
• As production costs
Cost Push Inflation
increase, aggregate supply decreases from AS1 to AS2 (given production is at full capacity), causing an increase in the price level from P1 to P2. The rationale behind this increase is that, for companies to maintain (or increase) profit margins, they will need to raise the retail price paid by consumers, thereby causing inflation.
Demand Pull Inflation
S Demand-pull inflation occurs when there is an increase in
aggregate demand, categorized by the four sections of the macro economy: households, businesses, governments and foreign buyers.
S When these four sectors concurrently want to purchase more
output than the economy can produce, they compete to purchase limited amounts of goods and services. Buyers in essence “bid prices up”, again, causing inflation.
S This excessive demand, also referred to as “too much money
chasing too few goods”, usually occurs in an expanding economy.
• When aggregate demand increases
without a change in aggregate supply, the „quantity supplied? will increase (given production is not at full capacity).
• If aggregate demand increases
Demand Pull Inflation
from AD1 to AD2, in the short run, this will not change (shift) aggregate supply, but cause a change in the quantity supplied as represented by a movement along the AS curve. The rationale behind this lack of shift in aggregate supply is that aggregate demand tends to react faster to changes in economic conditions than aggregate supply.
• As companies increase production
due to increased demand, the cost to produce each additional output increases, as represented by the change from P1 to P2. Demand-pull inflation can occur as companies, to maintain profit levels, pass on the higher cost of production to
Phillips Curve
• The Phillips Curve was
Inflation
developed in 1958 by A.W. Phillips, a professor in LSE.
• This curve depicts an inverse
i2 i* i1
relationship between the rate of unemployment and the rate of increase in the money wages.
• Higher the unemployment
lower is the rate of wage inflation and vice versa.
• This situation occurs in the
U2
U*
U1
Unemployment
case of demand induced inflation.
Stagflation
Inflation
A situation where a positive relation between unemployment and inflation exits. Stagflation is characterized by high growth of price level accompanied by economic stagnation caused primarily due to high levels of unemployment. This situation occurs when inflation is supply induced as it is not profitable for the producer to produce more so they lay workers off. Thus inflation here causes economic stagnation.
i1 i*
U*
U1
Unemploymen t
NAIRU
• Non Accelerating Inflation
Rate of Unemployment.
• The NAIRU is the lowest
unemployment rate that can be sustained without sustained upward pressure on inflation.
•It is a situation where the
demand and supply induced inflation cancel out each other?s effects such that variables are unchanged.
Costs of Inflation
• Creditors lose and debtors gain if the lender
does not anticipate inflation correctly. For those who borrow, this is similar to getting an interest-free loan.
•Uncertainty about what will happen next
makes corporations and consumers less likely to spend. This hurts economic output in the long run.
•People living off a fixed-income, such as
retirees, see a decline in their purchasing power and, consequently, their standard of living.
• The entire economy must absorb re-pricing
costs ("menu costs") as price lists, labels, menus and more have to be updated.
• If the inflation rate is greater than that of
other countries, domestic products become less competitive.
The question shouldn't be whether inflation is
10 Nations with Highest Inflation
Country Serbia Afghanistan Democratic Republic of Congo Inflation 15.5% 17% 18.2%
Uzbekistan Myanmar
Yemen San Tome & Principe Guinea Iraq Zimbabwe
19.2% 20%
20.8% 23.1% 30.9% 53.2% 355,000% (Hyperinflation)
Causes of Inflation
Global?
“Inflation is everywhere and always a monetary phenomenon”
-Milton Friedman
Indian Inflation
S
Rising Economies
S Exporters of Deflation S
Low Cost Production
S
S S
Cheap Labor
Resource Availability
Creators of Inflation
S S
Second moment of Demand Rising Wages
S Phillips Curve S Currency Appreciation
Exporting Inflation?
Inflation in Rising Economies
Oil Crises
?The 2004 shift
?Instability in Russia
?North Sea and Mexico
deposits declining
?Lower OPEC production
?Insatiable demand of
Asia
Global Output Gap
The SubPrime Effect
?Wiped out approximately $450
billion
?Fed and ECB injected around
$300 billion
?Excess liquidity ?Creation of investment opportunity
?Lack of Investment option in
US/Euro Area
?Led to speculative movement
Could Speculation be the reason?
Food Crises
?Lower harvest worldwide ?Crop damage ?Bio-fuels ?Rising population
Indian Imports
Sr. No. 1 2 3 4
Commodity Fuel, Power, Coal Sugar Edible Oil Fertilizers
Weightage 14.2 3.6 2.8 3.7
5
Iron & Steel
3.6
The Mechanics of Inflation and its Impact
1
Inflation Poor as fixed wage workers: Constt. Income Lesser no. of goods purchased for the same money Disparity increase Rich are mostly businessmen Benefit of increased money goes to the rich.
Import?? Export??
2
Inflation Domestic goods are expensive Foreign goods are cheaper
Exports hit
Imports favored
Trade deficit
3
Interest rate differential Inflation Forex Inflows(More dollars)
Increase demand
Rupee Appreciation
Increased money supply Intervention by govt. to curb appreciation.
Exporters hit
EXCHANGE RATES???
DEBT MARKET
4
22000 20000
EQUITY MARKET
Sensex (2008)
18000
16000 14000 12000 10000 01/08
02/08
03/08
04/08
05/08
06/08
07/
Major losers: elderly people and pensioners
Major losers: Corporate, Retail Investors
Returns in the markets
5
RETAIL SEGMENTA COMMA TO CONSUMERISM??
6
Impact Inflation: Corporate India under pressure
Year-on-year growth in input costs, interest rate and rising bills for power, fuel, salaries and wages are eating into their margins. Beyond a certain level the sale price (in every sector) cannot be increased
6? in Stagflation India ?
Simultaneous with rising inflation, growth indicators are deteriorating (reflected in the May IIP numbers). Expect monetary tightening in July to be nuanced rather than aggressive.
Public Policy Measures
S
Policy Measures
Fiscal Monetary
Taxation Excise duty Future Trade Export policy Subsidies
CRR SLR Interest rate MSS REPO REVERSE REPO
Long Term solutions
Productivity
Natural and renewable resources
Rationing and public transport
Thank You
S
doc_298435639.pptx