Causes of Infalation Scence 1991

7/27/2019 Causes of Infalation Scence 1991

1/5

CAUSES OF INFLATION SINCE 1991

INTRODUCTION

Inflation is defined as a general rise in prices of all commodities. It is not the rise in the price of

my favorite commodity, but the overall rise in the prices of all the goods and services

manufactured and consumed within the territory of a nation. When we say that the monthly rateof Inflation is 12%, what it means is that on an average, the prices of all goods and services have

increased by 12% in the period of last one month. The balance of payments crisis, resulting from

the underlying imbalances in the form of high inflation, high fiscal and current account deficits

during the 1980s marks the beginning of this phase in 1991. The nature of the crisis was so

grave that it warranted immediate correction of the situation. A series of reforms, in the name of

Macroeconomic Stabilization Programme and Structural Adjustment Programme, covering the

industrial, financial, fiscal and external sectors were introduced. The first half of the 1990s

witnessed a resurgence of inflationary tendencies with the inflation rate averaging just above

10% during 1991-92 to 1995-96. The economic survey58 (1991-92), in this respect, stated that

the buildup of inflationary pressure is mainly attributable to excess demand arising from the

large and persistent fiscal deficits over the years, resulting in excessive growth in money supply

and a liquidity overhang. There have also been supply and demand imbalances in sensitive

commodities like pulses, edible oils, etc. due to shortfalls in domestic production and constraints

in importing desired quantities due to the severe foreign exchange crunch.

MEASUREMENT OF INFLATION IN INDIA

Inflation is the rate of change of general price level. For measuring the general price level, index

numbers are constructed by taking weighted average of prices of individual goods and services.The weight assigned to each good or service reflects the relative importance of that good or

service in the economy or in the consumption basket of consumers and producers. The general

price index so constructed indicates the overall magnitude of prices of goods and services. The

comparison of general price index over a period of time gives us the variation in the general

price level, which is nothing but the rate of inflation. In India, there are mainly three types of

measures of general price level namely (i) wholesale price index (WPI), (ii) consumer price

index (CPI), and (iii) Implicit GDP deflator3. The rate of inflation can be measured in terms of

any one of these three measures.

ISSUES OF INFLATION IN INDIA

The challenges in developing economy are many, especially when in context of the Monetary

Policy with the Central Bank, the inflation and price stability phenomenon. There has been a

universal argument these days when monetary policy is determined to be a key element in

depicting and controlling inflation. The Central Bank works on the objective to control and have

a stable price for commodities. A good environment of price stability happens to create saving

mobilization and a sustained economic growth. The former Governor of RBI C. Rangarajan
http://en.wikipedia.org/wiki/Monetary_Policyhttp://en.wikipedia.org/wiki/Monetary_Policyhttp://en.wikipedia.org/wiki/Central_Bankhttp://en.wikipedia.org/wiki/Inflationhttp://en.wikipedia.org/wiki/Phenomenonhttp://en.wikipedia.org/wiki/C._Rangarajanhttp://en.wikipedia.org/wiki/C._Rangarajanhttp://en.wikipedia.org/wiki/Phenomenonhttp://en.wikipedia.org/wiki/Inflationhttp://en.wikipedia.org/wiki/Central_Bankhttp://en.wikipedia.org/wiki/Monetary_Policyhttp://en.wikipedia.org/wiki/Monetary_Policy


2/5

points out that there is a long-term trade-off betweenoutput andinflation.He adds on that short-

term trade-off happens to only introduce uncertainty about the price level in future. There is an

agreement that the central banks have aimed to introduce the target of price stability while an

argument supports it for what that means in practice.

1. The Optimal Inflation RateIt arises as the basis theme in deciding an adequatemonetary policy.There are two debatableproportions for an effective inflation,whether it should be in the range of 1-3 per-cent as theinflation rate that persists in the industrialized economy or should it be in the range of 6-7 per-

cents. While deciding on the elaborate inflation rate certain problems occur regarding its

measurement. The measurement bias has often calculated an inflation rate that is comparatively

more than in nature. Secondly, there often arises a problem when the quality improvements inthe product are in need to be captured out, hence it affects the price index. The consumer

preference for cheaper goods affects the consumption basket at costs, for the increased

expenditure on the cheaper goods takes time for the increased weight and measuring inflation.

2. Money Supply and InflationThe Quantitative Easing by the central banks with the effect of an increased money supply in an

economy often helps to increase or moderate inflationary targets. There is a puzzle formation

between low-rate of inflation and a high growth of money supply. When the current rate ofinflation is low, a high worth of money supply warrants the tightening of liquidity and an

increased interest rate for a moderate aggregate demand and the avoidance of any potential

problems. Further, in case of a low output a tightened monetary policy would affect the

production in a much more severe manner. The supply shocks have known to play a dominantrole in the regard of monetary policy. The bumper harvest in 1998-99 with a buffer yield in

wheat, sugarcane, and pulses had led to an early supply condition further driving their pricesfrom what were they in the last year. The increased import competition since 1991 with thetradeliberalization in place have widely contributed to the reduced manufacturing competition with a

cheaper agricultural raw materials and the fabric industry. These cost-saving driven technologies

have often helped to drive a low-inflation rate. The normal growth cycles accompanied with the

international price pressures has several times being characterized by domestic uncertainties.

3. Global TradeInflation in India generally occurs as a consequence of global traded commodities and the severalefforts made by TheReserve Bank of India to weakenrupee againstdollar.This was done after

the Pokhran Blasts in 1998.

This has been regarded as the root cause ofinflation crisis rather thanthe domesticinflation.According to some experts the policy of RBI to absorb all dollars cominginto the Indian Economy contributes to the appreciation of the rupee. When the US dollar has

shrieked by a margin of 30%,RBI had made a massive injection of dollar in the economy make

it highly liquid and this further triggered off inflation in non-traded goods. The RBI pictureclearly portrays forsubsidizing exports with a weak dollar-exchange rate. All these account for a

dangerous inflationary policies being followed by the central bank of the country. Further, on

account of cheap products beingimported in the country which are made on a high technological
http://en.wikipedia.org/wiki/Outputhttp://en.wikipedia.org/wiki/Inflationhttp://en.wikipedia.org/wiki/Monetary_policyhttp://en.wikipedia.org/wiki/Inflationhttp://en.wikipedia.org/wiki/Inflationhttp://en.wikipedia.org/wiki/Inflationhttp://en.wikipedia.org/wiki/Inflationhttp://en.wikipedia.org/wiki/Monetary_policyhttp://en.wikipedia.org/wiki/Trade_liberalizationhttp://en.wikipedia.org/wiki/Trade_liberalizationhttp://en.wikipedia.org/wiki/Inflationhttp://en.wikipedia.org/wiki/Reserve_Bank_of_Indiahttp://en.wikipedia.org/wiki/Rupeehttp://en.wikipedia.org/wiki/Dollarhttp://en.wikipedia.org/wiki/Inflationhttp://en.wikipedia.org/wiki/Inflationhttp://en.wikipedia.org/wiki/Dollarhttp://en.wikipedia.org/wiki/RBIhttp://en.wikipedia.org/wiki/Inflationhttp://en.wikipedia.org/wiki/RBIhttp://en.wikipedia.org/wiki/Subsidizinghttp://en.wikipedia.org/wiki/Inflationaryhttp://en.wikipedia.org/wiki/Central_bankhttp://en.wikipedia.org/wiki/Importedhttp://en.wikipedia.org/wiki/Importedhttp://en.wikipedia.org/wiki/Central_bankhttp://en.wikipedia.org/wiki/Inflationaryhttp://en.wikipedia.org/wiki/Subsidizinghttp://en.wikipedia.org/wiki/RBIhttp://en.wikipedia.org/wiki/Inflationhttp://en.wikipedia.org/wiki/RBIhttp://en.wikipedia.org/wiki/Dollarhttp://en.wikipedia.org/wiki/Inflationhttp://en.wikipedia.org/wiki/Inflationhttp://en.wikipedia.org/wiki/Dollarhttp://en.wikipedia.org/wiki/Rupeehttp://en.wikipedia.org/wiki/Reserve_Bank_of_Indiahttp://en.wikipedia.org/wiki/Inflationhttp://en.wikipedia.org/wiki/Trade_liberalizationhttp://en.wikipedia.org/wiki/Trade_liberalizationhttp://en.wikipedia.org/wiki/Monetary_policyhttp://en.wikipedia.org/wiki/Inflationhttp://en.wikipedia.org/wiki/Inflationhttp://en.wikipedia.org/wiki/Inflationhttp://en.wikipedia.org/wiki/Inflationhttp://en.wikipedia.org/wiki/Monetary_policyhttp://en.wikipedia.org/wiki/Inflationhttp://en.wikipedia.org/wiki/Output


3/5

and capital intensive techniques happen to either increase the price of domestic raw materials in

the global market or they are forced to sell at a cheaper price, hence fetching heavy losses.

CAUSES OF INFLATION SINCE 1991

There are several factors which help to determine the inflationary impact in the country and

further help in making a comparative analysis of the policies for the same.The major determinantof the inflation in regard to the employment generation and growth is depicted by the Phillips

curve.

1. Demand FactorsIt basically occurs in a situation when the aggregate demand in the economy has exceeded the

aggregate supply. It could further be described as a situation where too much money chases justfew goods. A country has a capacity of producing just 550 units of a commodity but the actual

demand in the country is 700 units. Hence, as a result of which due to scarcity in demand the

prices of the commodity rises. This has generally been seen in India in context with theagrarian

society where due to droughts and floods or inadequate methods for the storage of grains leads tolesser or deteriorated output hence increasing the prices for the commodities as the demand

remains the same.

2. Supply FactorsThe supply side inflation is a key ingredient for the rising inflation in India. The agricultural

scarcity or the damage in transit creates a scarcity causing high inflationary pressures. Similarly,

the high cost of labor eventually increases the production cost and leads to a high price for thecommodity. The energies issues regarding the cost of production often increases the value of the

final output produced. These supply driven factors have basically have afiscal tool for regulation

and moderation. Further, the global level impacts of price rise often impacts inflation from thesupply side of the economy.

3. Domestic FactorsThe underdeveloped economies like India have generally a lesser developed financial market

which creates a weak bonding between the interest rates and the aggregate demand. Thisaccounts for the real money gap that could be determined as the potential determinant for the

price rise and inflation inIndia.There is a gap in India for both the output and the real money

gap. The supply of money grows rapidly while the supply of goods takes due time which causes

increased inflation. Similarly Hoarding has been a problem of major concern in India where

onions prices have shot high in the sky. There are several other stances for the gold and silvercommodities and their price hike.

[6]

4. External FactorsThe exchange rate determination is an important component for the inflationary pressures that

arises in theIndia.The liberal economic perspective inIndia affects the domestic markets. As the

prices in United States Of America rises it impacts India where the commodities are now
http://en.wikipedia.org/wiki/Inflationhttp://en.wikipedia.org/wiki/Phillips_curvehttp://en.wikipedia.org/wiki/Phillips_curvehttp://en.wikipedia.org/wiki/Agrarian_societyhttp://en.wikipedia.org/wiki/Agrarian_societyhttp://en.wikipedia.org/wiki/Inflationhttp://en.wikipedia.org/wiki/Inflationhttp://en.wikipedia.org/wiki/Fiscalhttp://en.wikipedia.org/wiki/Inflationhttp://en.wikipedia.org/wiki/Indiahttp://en.wikipedia.org/wiki/Inflationhttp://en.wikipedia.org/wiki/Indiahttp://en.wikipedia.org/wiki/Inflationhttp://en.wikipedia.org/wiki/Hoardinghttp://en.wikipedia.org/wiki/Commoditieshttp://en.wikipedia.org/wiki/Inflation_in_India#cite_note-6http://en.wikipedia.org/wiki/Inflation_in_India#cite_note-6http://en.wikipedia.org/wiki/Inflation_in_India#cite_note-6http://en.wikipedia.org/wiki/Indiahttp://en.wikipedia.org/wiki/Indiahttp://en.wikipedia.org/wiki/United_States_Of_Americahttp://en.wikipedia.org/wiki/Indiahttp://en.wikipedia.org/wiki/Indiahttp://en.wikipedia.org/wiki/United_States_Of_Americahttp://en.wikipedia.org/wiki/Indiahttp://en.wikipedia.org/wiki/Indiahttp://en.wikipedia.org/wiki/Inflation_in_India#cite_note-6http://en.wikipedia.org/wiki/Commoditieshttp://en.wikipedia.org/wiki/Hoardinghttp://en.wikipedia.org/wiki/Inflationhttp://en.wikipedia.org/wiki/Indiahttp://en.wikipedia.org/wiki/Inflationhttp://en.wikipedia.org/wiki/Indiahttp://en.wikipedia.org/wiki/Inflationhttp://en.wikipedia.org/wiki/Fiscalhttp://en.wikipedia.org/wiki/Inflationhttp://en.wikipedia.org/wiki/Inflationhttp://en.wikipedia.org/wiki/Agrarian_societyhttp://en.wikipedia.org/wiki/Agrarian_societyhttp://en.wikipedia.org/wiki/Phillips_curvehttp://en.wikipedia.org/wiki/Phillips_curvehttp://en.wikipedia.org/wiki/Inflation


4/5

imported at a higher price impacting the price rise. Hence, the nominal exchange rate and the

import inflation are a measures that depict the competitiveness and challenges for the economy.

MEASURE TO CONTROL INFLATION

1. Monetary policyGovernments and central banks primarily use monetary policy to control inflation.Central banks

such as the U.S.Federal Reserve increase theinterest rate,slow or stop the growth of the money

supply, and reduce the money supply. Some banks have a symmetrical inflation target while

others only control inflation when it rises above a target, whether express or implied. Most

central banks are tasked with keeping their inter-bank lending rates at low levels, normally to a

target annual rate of about 2% to 3%, and within a targeted annual inflation range of about 2% to

6%. Central bankers target a low inflation rate because they believe deflation endangers the

economy. Higher interest rates reduce the amount of money because less people seek loans, and

loans are usually made with new money. When banks make loans, they usually first create new

money, then lend it. A central bank usually creates money lent to a national government.Therefore, when a person pays back a loan, the bank destroys the money and the quantity of

money falls.

2. Fixed exchange ratesUnder 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.

Under theBretton Woods agreement, most countries around the world had currencies that were

fixed to the US dollar. This limited inflation in those countries, but also exposed them to the

danger ofspeculative attacks.

3. Gold standardThe 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 ofspecie

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 theBretton Woods System.
http://en.wikipedia.org/wiki/Central_bankhttp://en.wikipedia.org/wiki/Federal_Reservehttp://en.wikipedia.org/wiki/Interest_ratehttp://en.wikipedia.org/wiki/Symmetrical_inflation_targethttp://en.wikipedia.org/wiki/Bretton_Woods_systemhttp://en.wikipedia.org/wiki/Speculative_attackhttp://en.wikipedia.org/wiki/Bullion_coinhttp://en.wikipedia.org/wiki/Silver_certificatehttp://en.wikipedia.org/wiki/Bretton_Woods_Systemhttp://en.wikipedia.org/wiki/Bretton_Woods_Systemhttp://en.wikipedia.org/wiki/Silver_certificatehttp://en.wikipedia.org/wiki/Bullion_coinhttp://en.wikipedia.org/wiki/Speculative_attackhttp://en.wikipedia.org/wiki/Bretton_Woods_systemhttp://en.wikipedia.org/wiki/Symmetrical_inflation_targethttp://en.wikipedia.org/wiki/Interest_ratehttp://en.wikipedia.org/wiki/Federal_Reservehttp://en.wikipedia.org/wiki/Central_bank


5/5

REFERENCE

Book

Reddy, Y.V. (1999): Inflation in India: Status and Issues in Y.V. Reddy (2000):Monetary and Financial Sector Reforms in India. Distributors Ltd., New Delhi, p. 46-47.

Website

http://en.wikipedia.org/wiki/infalation in india

Causes of Infalation Scence 1991

Documents

Transcript of Causes of Infalation Scence 1991