Inflation

[UPSC Notes]

Inflation Meaning
In simple words, Inflation is the rise in the price of goods and services within an
economy over a period of time due to which each unit of currency has less
purchasing power.
• Inflation can have positive as well as negative consequences like inflation is
good for tangible assets but has a negative effect on cash holdings.
• It is estimated as the percentage rate of change in price index over the
reference time period.
• Currently in India inflation rate is measured with the help of the Consumer
Price Index- combined (Base year- 2012).
• Till April 2014, the Inflation rate was measured with the help of WPI
(Wholesale Price Index).
• Rate of Inflation= (Current period price index-Reference period price
index)/(Reference Period Price Index)×100

Types of Inflation
We have segmented the types of inflation on the basis of causes and speed or
intensity.

Based on causes inflation is divided into the following

types
1. Currency inflation: The printing of currency notes causes this type of
inflation.
2. Credit inflation: Credit expansion leads to a rise in price level causing
inflation.
3. Deficit-induced inflation: When expenditure exceeds revenue, the
government can ask RBI to print money to meet the budget deficit causing
deficit-induced inflation.
4. Demand-Pull inflation: An increase in aggregate demand over the available
output leads to a rise in the price level and is called demand-pull inflation.
5. Cost-push inflation: Inflation in an economy may arise from the overall
increase in the cost of production and is known as cost-push inflation.
Based on Speed or Intensity, Inflation is divided into as
follows:

1. Creeping or Mild Inflation

• When the speed of upward thrust in prices is slow but small, it is
known as creeping inflation.
• It is helpful for economic development.
• Price rise at a very small rate (<3%).
2. Walking or Trotting Inflation
• When prices rise moderately and the annual inflation rate rises by a
single digit, walking inflation occurs.
• It is the time when government should focus on the issue.
• Price rise at moderate rate (3% <Inflation< 10%)
3. Galloping and Hyperinflation:
• When creeping and walking inflation are left unchecked, the rate of
inflation will rise above 10% and is termed galloping inflation.
• This leads to instability of the economy.
• Hyperinflation is when the prices of goods and services rise more than
50% per month.
• It is the last stage of inflation.
• Examples: Germany in the 1920s, Zimbabwe in the 2000s, American
Civil War, and Venezuela in 2018.
• Price rise at very high rate (20% < Inflation < 100%)
4. Stagflation:
• It is a situation in which the inflation rate is high, the economic growth
rate slows, and unemployment remains steadily high.
• It is also known as recession inflation.
• It is a dilemma for economic policy, since actions intended to lower
inflation may worsen the unemployment situation.
5. Core Inflation
• Price rise in all goods and services except food and energy due to high
price fluctuations is core inflation.
• It is calculated as government needs a stable and true picture of
inflation.
6. Headline Inflation
• This measure considers total inflation in an economy, including food
and energy prices, which are more volatile.

Causes of Inflation
Some major causes of inflation include demand-pull factors, cost-push factors,
built-in inflation, and monetary inflation. We have covered all these causes in brief
below.
Demand-Pull Factors
These are the set of factors due to which there may be an increase in the demand
for goods and services in an economy. Its example includes
• Increase in government expenditure putting more money in the hands of the
public which in turn increases demand and prices automatically increase.
• Population increase
• Money hoarding
• Fluctuated consumption pattern.

Cost-Push Factors
This factor is a result of the increase in the prices of production process inputs. For
example: If wages increase then productivity, and an increase in the price of a
product can be seen.
• Increase in indirect taxes like custom and excise duty raise the cost of
production and increases the price.
• MSP (Minimum Support Price) increase
• Infrastructural issues
• Failed monsoon and disaster.

Built-in inflation
As the price of goods and services increases, labor expects and demands more
wages to maintain their cost of living that increasing prices and the wage-price
spiral continues

Monetary Inflation
Reserve Bank of India printing more money (deficit financing) can trigger inflation.
It is a sustained increase in the money supply of a country or currency area.

Remedies to Control Inflation

The remedies to solve the problems related to inflation are

Monetary Policy
The monetary policy of RBI aims to manage the quantity of money to meet the
requirements of different sectors of the economy and drive economic growth.

This policy is applicable by increasing interest rates and decreasing bond prices.
This helps to reduce the expenses during inflation that pause the economic growth
and the inflation rate.

Fiscal Policy
Fiscal policy can be taken by the government in two ways
 • Cutting expenditure on schemes, projects, spending, etc.
• Increasing direct or indirect tax.

Supply Managemnt Measures

• Import commodities that have less supply and Decrease exports
• Distribution through Public Distribution System
• Government may check on hoarding

Measurement of Inflation
Wholesale Price Index (WPI): Wholesale Price Index or WPI measures the changes
in the prices of goods sold and traded in bulk by wholesale businesses to other
businesses. It is released by the Economic Advisor in the Ministry of Commerce and
Industry.
• An upward surge in WPI indicates inflationary pressure in the economy.
• The base year is taken 2011-12 in India.
• Major components of WPI are primary articles subdivided into Food Articles
and Non-Food Articles.
• another component: Fuel & Power, Manufactured Goods like Textiles,
apparel, Metals, Sugar, Oils, and more.
• The monthly WPI shows average price changes of goods usually expressed in
ratios or percentages.
• However, it does not include services such as the health, IT, Education,
transport and unorganized sector, etc.

Consumer Price Index: It measures retail inflation in the economy by collecting

the change in prices of common goods and services like food, housing, apparel,
transportation, electronics, medical care, education, etc. This provides insights as to
how much a consumer can spend to be on par with the price change.

Producer Price Index: it measures the average price changes in the selling prices
over time received y the domestic producer.

Effects of Inflation on the Economy

Following are the effects of Inflation on the economy

• Due to inflation, some group faces losses while other group faces gains
• Due to inflation the demand decreases, which hamper production
• Imports increase and export decrease for other countries that have a direct
impact on the forex service
 • Sudden inflation rates are harmful to the overall economy. It causes
instability in the market that makes it difficult for the companies to plan their
long-term budget.

Effects of Increasing Inflation

Increasing Inflation has both positive and negative impacts. Below we have jotted
down both benefits and disadvantages of increasing inflation.
Benefits Disadvantages

-Lower interest rate -Lower purchasing power

-Currency depreciation -Salaried and pensioners suffer
-Profits of business people -Imports suffer due to depreciation
-Export benefits due to currency of currency
depreciation -Decrease in the real wages
-Increasing nominal wage -Decline in competitiveness
-Investment, savings, and rise in -Rupee purchasing power declines
employment in short term.

Terms Related to Inflation

• Disinflation: Decrease in the rate of inflation
• Deflation: Negative inflation or persistent price level decrease.
• Reflation: This happens when the Price level increases because the economy
recovers from recession.
• Stagflation: When stagnation and inflation coexist in the economy.
Stagnation- low national income growth and high unemployment. Inflation +
Recession (Unemployment)
• Misery index: Rate of inflation + Rate of unemployment
• Inflationary gap: Aggregate demand > Aggregate supply
• Deflationary gap: Aggregate supply > Aggregate demand
• Suppressed / Repressed inflation: Aggregate demand > Aggregate supply.
The government will not allow the rising of prices in this.
• Open inflation: Situation where price level rises without any price control
measures by the government.