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Effects of Inflation

The document discusses the effects of inflation on various groups, including producers who benefit from rising prices, fixed income earners who struggle as their purchasing power declines, and the differing impacts on debtors and creditors. It also outlines methods of credit control used by central banks, including qualitative methods like credit rationing and moral suasion, and quantitative methods such as bank rate fixation and cash reserve ratio. These controls aim to manage the money supply and influence lending practices to stabilize the economy.

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pranaysingha2002
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5 views

Effects of Inflation

The document discusses the effects of inflation on various groups, including producers who benefit from rising prices, fixed income earners who struggle as their purchasing power declines, and the differing impacts on debtors and creditors. It also outlines methods of credit control used by central banks, including qualitative methods like credit rationing and moral suasion, and quantitative methods such as bank rate fixation and cash reserve ratio. These controls aim to manage the money supply and influence lending practices to stabilize the economy.

Uploaded by

pranaysingha2002
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Effects of Inflation

1. Effects on Producers (Businessmen, Traders, and Real Estate Holders)

What happens?
During inflation, prices of goods and assets increase. For producers and traders, this means the
value of the items they already have (inventory) also goes up.

Example:
If a shopkeeper has 100 bags of rice priced at $20 each and inflation causes the price to rise to
$25, the shopkeeper earns more when selling the same rice. Similarly, real estate holders benefit
as property prices increase.

2. Effects on Fixed Income Groups

What happens?
People who earn a fixed salary, pension, or income (like teachers, clerks, and retired individuals)
suffer because their income doesn’t increase as quickly as the prices of goods and services. As a
result, they can afford fewer things over time.

Example:
A teacher earning $1,000 per month could buy 10 items costing $100 each. After inflation, if
each item now costs $120, the teacher can only buy 8 items with the same salary.

3. Effects on Debtors and Creditors

Debtors (Borrowers) Gain

If someone borrows money and repays it during inflation, the value of the money they repay is
lower than when they borrowed it.

Example:
A borrower takes $1,000 to buy a bike when bikes cost $1,000. After inflation, bikes cost $1,200,
but the borrower still repays only $1,000. Thus, the debt feels lighter.

Creditors (Lenders) Lose

The lender gets back the same amount of money they gave but can buy fewer things with it
because the value of money has decreased.
Example:
A lender loans $1,000, expecting to buy a bike. After inflation, they get the $1,000 back but now
need $1,200 to buy the same bike.

Methods of Credit Control by Central Banks

Qualitative Control Methods

1. Credit Rationing

What it means?
The central bank tells commercial banks to limit loans for specific purposes (like luxury projects)
and prioritize essential purposes (like agriculture).

Example:
A central bank may instruct banks to avoid giving loans for buying expensive cars and instead
give loans for farming equipment.

2. Moral Suasion

What it means?
The central bank persuades or requests commercial banks to follow its monetary policy through
suggestions, advice, or appeals.

Example:
The central bank might request banks to lower interest rates on loans for small businesses to
boost entrepreneurship.

3. Fixation of Marginal Requirements on Secured Loans

What it means?
Banks lend money against security (like goods or property) but don’t lend the full value of the
security. The gap is called the "marginal requirement."

Example:
A trader pledges goods worth $100,000 as security but the bank only gives a loan of $80,000.
The marginal requirement here is $20,000.

4. Direct Action
What it means?
If commercial banks don’t follow the central bank’s policies, the central bank can take direct
actions, like penalizing them.

Example:
If a bank keeps lending excessively for speculative trading against central bank guidelines, the
central bank may fine it or restrict its operations.

Quantitative Control Methods

1. Bank Rate Fixation

What it means?
The central bank sets the interest rate at which it lends money to commercial banks.

Example:
If the central bank increases the rate from 4% to 5%, loans become costlier for commercial
banks, and they lend less to the public, reducing money supply.

2. Cash Reserve Ratio (CRR)

What it means?
Banks must keep a portion of their deposits as cash with the central bank.

Example:
If a bank receives $1,000 in deposits and the CRR is 10%, the bank must keep $100 with the
central bank and can only use $900 for lending.

3. Statutory Liquidity Ratio (SLR)

What it means?
Banks must maintain a certain percentage of their deposits as liquid assets (like government
bonds or gold).

Example:
If a bank has deposits worth $10 million and the SLR is 20%, the bank must hold $2 million in
liquid assets.

4. Repo Rate
What it means?
The interest rate at which the central bank lends short-term money to commercial banks against
security.

Example:
If the repo rate is increased, commercial banks have to pay more interest to borrow money, so
they borrow less and give fewer loans to customers, reducing money in the economy.

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