Inflation

INFLATIONA Project Report

Submitted by

Pawan Pant

Enrollment No.072460957

Address : 19/1288, Sector-19, Indira Nagar, Lucknow-226016

in partial fulfillment of the requirementfor the award of the degree

OfMaster in Business Administration (MBA B & f)

IN[BANKING & Finance]

Indira Gandhi Open University (IGNOU)

<April 2010>

INFLATION (A Project Report by Pawan Pant)

Acknowledgement

At the out set, I am thankful to My University (Indira Gandhi National Open University, Delhi), my Regional center at Lucknow and the Study Center at KKC , Lucknow, The respective authorities for providing me an opportunity to undertake my MBA Post Graduate Diploma in Business Administration (PGDBA).I am thankful to the management of my organization (HDFC Bank), my Project supervisor Mrs Asha Baijal (Designation ) for Guiding me in completion of this project..I am also thankful to My Zonal Head ( Mr Arun Mendiratta) and Cluster Head (Mr Rishi Raj),

ANDMy other colleagues, Mrs Sumeet Bhatia and Mr Dhiraj Kumar Rai for providing me valuable suggestions and guidance during the project.


Executive Summary:

The one Thing, which is rising Week after Week, Mouth after Mouth and which has given

the Sleepless Nights to to Congress Government in the last few months, which affects

from Prime Minister to Common Man. YES, IT IS INFLATION.

Inflation is commonly understood as a situation of substantial and rapid general

increase in the level of prices and consequent deterioration in the value of money over a

period of time. In other words inflation usually refers to a persistent and rapid rise in the

general price level, which reduces the value of money or its purchasing power over a

period of time.


TABLE OF CONTENTS

1. Introduction of Inflation

1.1 Inflation: Definition

1.2 How to measure Inflation?

1.3 Features of Inflation

1.4 Types of Inflation

- Creeping Inflation

- Walking Inflation

- Running Inflation

- Galloping or Hyper-Inflation

- Cost-Push Inflation

- Demand-pull Inflation

- Built-in Inflation

- Chronic Inflation

- Core Inflation

- Headline inflation

- Stealth Inflation

- Assets inflation

1.5 Others Terms related to Inflation

- Deflation

- Disinflation

- Inflationary spikes

- Reflation

1.6 Causes of Inflation

A) Monetary Factors

B) Non-monetary Factors

C) Structural Factors.

2. Trace the Effects of Inflation

2.1 Economic Effects of Inflation

2.1.1 Effects on production

2.1.2 Effects of Inflation on Income Distribution


2.1.3. Effect Of Inflation on Consumption And Welfare

2.1.4. Effects of Inflation on Foreign Trade

2.1.5. Social and Political Effects

2.1.6. Effects On Manufacturers

3. Measures to Control Inflation

1) Monetary Measures

2) Fiscal Measures

3) Other Non-monetary Measures

4. Price Rise still pinching Common Man's Pocker

5. Tackling Inflation

6. Measures of Inflation

7. Inflation & India (WPI)

8. Indian Scenario

- Reasons for inflation in India

- Inflation Pressure over the Last Few Months

- Inflation in India and other Developed Countries

- Inflation during 1980's and 1990's

- Global Inflation A Comparison With India

9. Issues in Measuring Inflation

10. An Example Of How Inflation Can Be Dangerous (Case)

11. Reserve Bank of India

- Introduction

- Functions of Reserve Bank of India

- Role of RBI

- Control Measures of RBI

- Monetary Policy

- Monetary & Credit Policy

12. Conclusion

13. Annexure


Introduction

of

‘Inflation’


1.1 DEFINITION

According to Crowther, “Inflation is a state in which the value of money is falling i.e.

prices are rising.”

1.2 HOW TO MEASURE INFLATION?

If the price level in the current year is ‘P1’ & in the previous year is ‘Po’, then inflation

for the current year is


1.3 FEATURES OF INFLATION:

1. Inflation leads to persistent remarkable and continuous rise in general price level.

2. Inflation is a scarcity oriented.

3. Inflation is a dynamic phenomenon. It is not a state of high prices, but a process of

rising prices.

4. Inflation is a state of disequilibria. It involves an imbalance between aggregate

demand and aggregate supply.

5. Inflation is a pure monetary phenomenon.

6. Real inflation takes place only after full employment.

7. Inflation is a longer period phenomenon.


1.4 TYPES OF INFLATION:

Inflation is often classified on three different criteria. Firstly, one might distinguish

between various types of inflation on the basis of speed at which the general price level

rises. Secondly, one way distinguishes between open and suppressed inflation. Finally, as

we find in the modern macroeconomic theory, inflation is classified on the basis of the

factors, which induce it.

On the criterion of the rate at which the general price level rises, we have the following

types of inflation:

1. Creeping Inflation

2. Walking Inflation

3. Running Inflation

4. Galloping or Hyper-Inflation

5. Cost-Push Inflation

6. Demand-pull Inflation

7. Built-in Inflation

8. Chronic Inflation

9. Core Inflation

10. Headline inflation

11. Stealth Inflation

12. Assets inflation

1. Creeping Inflation

An extremely mild form of inflation is often characterized as creeping inflation. In this

case prices rise at a rate of around 2 percent per annum. In case the rate of inflation

does not register further increase, those a mild does of inflation may not have any

adverse effects on the economy.

Creeping inflation sometimes provides necessary inducement to investors. The debatable

question about the creeping inflation however, is whether it would not eventually gather

momentum and thereby creates distortions in the economy. The world has witnessed both

types of situations. Certain countries have lived with mild inflation’s over long periods


and their economies in these periods have registered rapid economic growth. In other

countries, creeping inflation eventually accelerated and caused the collapse of the

economy.

2. Walking Inflation

The walking inflation in terms of degree of prices rise is an intermediate situation

between the creeping and running inflation’s. The rate of inflation in this case is

distinctly higher than that in the case of the creeping inflation. Since the walking inflation

does not invite widespread protests, the monetary authorities do often not take it

seriously and they don’t undertake timely corrective measures. It also sometimes leads to

balance of payments problems because on the one hand it induces imports and, on the

other discourages exports.

3. Running Inflation

The running inflation is considered to be a stage between walking inflation and

hyperinflation. Since the hyperinflation is often defined as a situation in which prices rise

at a rate of at least 40 percent per month.

When prices rise at a rate exceeding 4-5 percent per month the situation becomes

alarming. This inflation redistributes income to the disadvantages of the fixed income

groups such as workers, pensioners and salary earners, it is considered to be highly

unjust. Further a running inflation also creates conditions of uncertainty. If prices rises

from 10-12 percent than the economy will be collapsed and there will be no monetary

measures to prove effective.

4. Hyper Inflation

The hyper-inflation refers to a situation in which prices rise at an alarming rate of 40

percent per month or even more. The most notable examples of hyper-inflation are to be

found in the economic histories of Germany, Austria, Russia, Poland, Greece, Hungary

and China. In hyperinflation money loses its importance as a store of value as no one

holds it for precautionary and speculative purposes. In fact, a hyper-inflation invariably


leads to a monetary collapse and national catastrophe. However, it is important to

recognise the fact that hyper-inflation does not arise abruptly. It is always a result of

wrong policies of the government. Whenever in some country the government indulges

recklessly in unproductive expenditures, which are largely financed by borrowing from

the Central Bank of the Country, a process of inflation begins which often culminates in

hyper-inflation.

5. Cost-Push Inflation

Aggregate supply is the total volume of goods and services produced by an economy at a

given price level. When there is a decrease in the aggregate supply of goods and services

stemming from an increase in the cost of production, we have cost-push inflation. Cost-

push inflation basically means that prices have been “pushed up” by increases in costs of

any of the four factors of production (labour, capital, land or entrepreneurship) when

companies are already running at full production capacity. 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).

Management Practice under Cost-Push Inflation:

To understand better their effect on inflation, let’s take a look into how and why

production costs can change. A company may need to increases wages if labourers

demand higher salaries (due to increasing prices and thus cost of living) or if labour

becomes more specialized. If the cost of labour, a factor of production, increases, the

company has to allocate more resources to pay for the creation of its goods or services.

To continue to maintain (or increase) profit margins, the company passes the increased

costs of production on to the consumer, making retail prices higher. Along with

increasing sales, increasing prices is a way for companies to constantly increase their

bottom lines and essentially grow. Another factor that can cause increases in production

costs is a rise in the price of raw materials. This could occur because of scarcity of raw

materials, an increase in the cost of labour and/or an increase in the cost of importing

raw materials and labour (if the they are overseas), which is caused by a depreciation in


their home currency. The government may also increase taxes to cover higher fuel and

energy costs, forcing companies to allocate more resources to paying taxes.

To visualize how cost-push inflation works, we can use a simple price-quantity graph

showing what happens to shifts in aggregate supply. The graph below shows the level of

output that can be achieved at each price level. As production costs 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.


6. Demand-Pull Inflation

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. 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, are causing inflation. This

excessive demand, also referred to as “too much money chasing too few goods”, usually

occurs in

an expanding economy.

The term demand-pull inflation is mostly associated with Keynesian economics.

Management Practice under Demand-Pull Inflation:

The increase in aggregate demand that causes demand-pull inflation can be the result of

various economic dynamics. For example, an increase in government purchases can

increase aggregate demand, thus pulling up prices.

Another factor can be the depreciation of local exchange rates, which raises the price of

imports and, for foreigners, reduces the price of exports. As a result, the purchasing of

imports decreases while the buying of exports by foreigners increases, thereby raising the

overall level of aggregate demand (we are assuming aggregate supply cannot keep up

with aggregate demand as a result of full employment in the economy). Rapid overseas

growth can also ignite an increase in demand as more exports are consumed by

foreigners. Finally, if government reduces taxes, households are left with more

disposable income in their pockets. This in turn leads to increased consumer spending,

thus increasing aggregate demand and eventually causing demand-pull inflation. The

results of reduced taxes can lead also to growing consumer confidence in the local

economy, which further increases aggregate demand.

Demand-pull inflation is a product of an increase in aggregate demand that is faster than


the corresponding increase in aggregate supply. When aggregate demand increases

without a change in aggregate supply, the ‘quantity supplied’ will increase (given

production is not at full capacity). Looking again at the price-quantity graph, we can see

the relationship between aggregate supply and demand. If aggregate demand increases

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. The rationale

behind this change is that companies would need to pay workers more money (e.g.

overtime)and/or invest in additional equipment to keep up with demand, thereby

increasing the cost of production. Just like cost-push inflation, demand-pull inflation can

occur as companies, to maintain profit levels, pass on the higher cost of production to

consumer’s prices.


7. Built-in Inflation

Built-in inflation is an economic concept referring to a type of inflation that resulted from

past events and persists in the present. It thus might be called hangover inflation.


At any one time, built-in inflation represents one of three major determinants of the

current inflation rate. In Robert J. Gordon's triangle model of inflation, the current

inflation rate equals the sum of demand-pull inflation, supply shock inflation, and built-in

inflation. "Demand-pull inflation" refers to the effects of falling unemployment rates

(rising real gross domestic product) in the Phillips curve model, while the other two

factors lead to shifts in the Phillips curve.

The built-in inflation we see now started with either persistent demand-pull or large cost-

push (supply-shock) inflation in the past. It then became a "normal" aspect of the

workings of the economy due to the roles of inflationary expectations and the price/wage

spiral.

Inflationary expectations play a role because if workers and employers expect inflation to

persist in the future, they will increase their (nominal) wages and prices now. (see real

vs. nominal in economics.) This means that inflation happens now simply because of

subjective views about what may happen in the future. Of course, following the generally

accepted theory of adaptive expectations, such inflationary expectations arise because of

persistent past experience with inflation.

The price/wage spiral refers to the conflictual nature of the wage bargain in modern

capitalism. (It is part of the conflict theory of inflation, referring to the objective side of

the inflationary process.) Workers and employers usually do not get together to agree on

the value of real wages. Instead, workers attempt to protect their real wages (or to attain

a target real wage) by pushing for higher money (or nominal) wages. Thus, if they expect

price inflation -- or have experienced price inflation in the past -- they push for higher

money wages. If they are successful, this raises the costs faced by their employers. To

protect the real value of their profits (or to attain a target profit rate or rate of return on

investment), employers then pass the higher costs onto consumers in the form of higher

prices. This encourages workers to push for higher money wages.

In the end, built-in inflation involves a vicious circle of both subjective and objective


elements, so that inflation encourages inflation to persist. It means that the standard

methods of fighting inflation using either monetary policy or fiscal policy to induce a

recession are extremely expensive, i.e., meaning large rises in unemployment and large

falls in real gross domestic product. This suggests that alternative methods such as wage

and price controls (incomes policies) may be needed as complementary to recessions in

the fight against inflation.

8. Chronic Inflation

Chronic inflation is characterized by much higher price increases than ordinary

inflation, at annual rates of 10% to 30% in some industrialized nations and even 100% or

more in a few developing countries. Chronic inflation tends to become permanent and

ratchets upwards to even higher levels as economic distortions and negative expectations

accumulate.

To accommodate chronic inflation, normal economic activities are disrupted Consumers

buy goods and services to avoid even higher prices; property speculation increases;

businesses concentrate on short-term investments; incentives to acquire savings,

insurance policies, pensions, and long-term bonds are reduced because inflation erodes

their future purchasing power; governments rapidly expand spending in anticipation of

inflated revenues; exporting nations suffer competitive trade disadvantages forcing them

to turn to protectionism and arbitrary currency controls.

9. Core Inflation

Core inflation is a measure of inflation which excludes certain items that face volatile

price movements e.g. food.

The preferred measure by the Federal Reserve of core inflation in the United States is the

core Personal consumption expenditures price index. This is based on chained dollars.

Since February 2000, the Federal Reserve Board’s semi-annual monetary policy reports

to Congress have described the Board’s outlook for inflation in terms of the PCE. Prior

to that, the inflation outlook was presented in terms of the CPI.


In explaining its preference for the PCE, the Board stated the chain-type price index for

PCE draws extensively on data from the consumer price index but, while not entirely free

of measurement problems, has several advantages relative to the CPI. The PCE chain-

type index is constructed from a formula that reflects the changing composition of

spending and thereby avoids some of the upward bias associated with the fixed-weight

nature of the CPI. In addition, the weights are based on a more comprehensive measure

of expenditures. Finally, historical data used in the PCE price index can be revised to

account for newly available information and for improvements in measurement

techniques, including those that affect source data from the CPI; the result is a more

consistent series over time. —Monetary Policy Report to the Congress, Federal

Reserve Board of Governors, Feb. 17, 2000

The older preferred measure of inflation in the United States was the Consumer Price

Index. This is still used as the indicator for most other countries, and is presented

monthly in the US by the Bureau of Labor Statistics.

This index tends to change more on a month to month basis than does "core inflation".

This is because core inflation eliminates products that can have temporary price shocks

(i.e. energy, food products). Core inflation is thus intended to be an indicator and

predictor of underlying long-term inflation.

The concept of core inflation as aggregate price growth excluding food and energy was

introduced in a 1975 paper by Robert J. Gordon. This is the definition of "core inflation"

most used for political purposes. Analysis by the Federal Reserve Bank of New York

indicates that this measure is no better than a moving average of the Consumer Price

Index as a predictor of inflation.

There are also other types of measuring inflation rates. In the United States the Dallas

Federal Reserve computes a trimmed mean PCE price index, which separates "noise"

and "signal". This is trimmed at 19.4% at the lower tail end and 25.4% at the upper tail.

The Cleveland Federal Reserve computes a Median CPI and a 16% trimmed mean CPI.


Trimmed means that the highest rises and declines in prices are trimmed by a certain

percentage, attributing to a more accurate measurement on core inflation. In relation to

this, the Median CPI is usually higher than the trimmed figures for both PCE and CPI.

There also is a median PCE, but is not used for any purpose in determining inflation.

10. Headline Inflation

Headline inflation is a measure of the total inflation within an economy and is affected by

areas of the market which may experience sudden inflationary spikes such as food or

energy. As a result, headline inflation may not present an accurate picture of the current

state of the economy. This differs from core inflation which excludes factors, such as food

and energy costs.

11. Stealth Inflation

Stealth Inflation is the term used to describe charges and fees created by business to gain

extra profit and revenue from its customers. The stealth part of the term is that business

will often use miscellaneous fees to charge customers without the customers consciously

knowing the fees existed, even though they may have agreed then signed a contract for

the goods and services the fee is hidden in a mirage of words and policies. The inflation

part of the term relates to the up charging of the service without actually providing

anything additional. Since most companies charge a fee to accept payment a portion gets

built into profit and revenue. A big example of stealth inflation can be overdraft fees from

banks surcharges from Telco providers, processing fees and installation fees.

12. Assets Inflation

Assets inflation is an economic phenomenon denoting a rise in price of assets, as opposed

to ordinary goods and services. Typical assets are financial instruments such as bonds,

shares, and their derivatives, as well as real estate and other capital goods.

13. Agflation

Agflation, a term coined in the late 2000s, describes generalised inflation led by rises in

Agricultural commodity prices. In the United States, agricultural prices are not generally


factored into core inflation figures. The term describes a situation in which "external" (ie

Agricultural) price rises drive up core inflation rates.

It has been claimed that the term was invented by analysts at Merrill Lynch in early

2007.

14. Stagflation

Stagflation is a macroeconomics term used to describe a period of inflation combined

with stagnation (that is, slow economic growth and rising unemployment), generally

including recession.

1.5 OTHER TERMS RELATED TO INFLATION

Deflation

Deflation is the opposite of inflation. Therefore, under the usual contemporary definition

of inflation, 'deflation' means a decrease in the general price level. Alternatively, the term

was used by the classical economists to refer to a decrease in the money supply; some

economists, including many Austrian school economists, still use the word in this sense.

The two meanings are closely related, since a decrease in the money supply is likely to

cause a decrease in the price level.

Deflation is considered a problem in a modern economy because of the potential of a

deflationary spiral and its association with the Great Depression, although not all

episodes of deflation correspond to periods of poor economic growth historically.

Disinflation

Disinflation is a decrease in the rate of inflation. Being how much prices are increasing

per unit of time, it can be expressed using the word disinflation The slowing of the rate of

inflation per unit of time.


For example one month the rate of inflation was 4.4% and the next month the rate of

inflation was 4.0%. In this instance the price of goods and services is still increasing;

however, it is increasing at a slower rate, 0.4% less, than a month before. It should not

be confused with deflation, which is an overall decrease in prices.

Inflationary spikes

Inflationary spikes occur when a particular section of the economy experiences a sudden

price rise possibly due to external factors. For example if a large amount of crop is

destroyed, the value of the remaining crop will rise sharply. This will distort the overall

measure of inflation within the economy (Headline inflation). Core inflation seeks to

avoid the influence of these spikes by excluding areas of the economy such as food and

energy, which may be susceptible to such shocks.

Reflation

Reflation is the act of stimulating the economy by increasing the money supply or by

reducing taxes. It is the opposite of disinflation. It can refer to an economic policy

whereby a government uses fiscal or monetary stimulus in order to expand a country's

output. This can possibly be achieved by methods that include reducing tax, changing the

money supply, or even adjusting interest rates. Just as disinflation is an acceptable

antidote to high inflation, reflation is considered to be an antidote to deflation (which,

unlike inflation, is considered bad regardless how high it is).

Originally it was used to describe a recovery of price to a previous desirable level after a

fall caused by a recession. Today it also (in addition to the above) describes the first

phase in the recovery of an economy with increasing demand from a slump.


1.6 CAUSES OF INFLATION

For controlling the rates of commodity, we must know why these rates are rising i.e.

inflating which means what are the reasons or causes behind inflation.

There are various factors which causes inflation in the economy which is as follows-

A) Monetary Factors

B) Non-monetary Factors

C) Structural Factors.

A) MONETARY FACTORS

1. Expansion of Money Supply

This is the basic factor, which causes inflation. Due to increase in expansion of money

supply, there is increase in demand of luxurious commodities. Credit facilities allotted by

bank are also the result of inflation. Deficit financing also contribute to the growth of

inflation.

2. Increase in Disposable Income

When the disposable income of people increases, demand for real goods and services

increases, causing a rise in price leading inflation.

3. Increase in Consumer Spending

As the income of the consumers rises, they spend more due to expenditure consumption

or demonstration effect, which raises the aggregate demand causing inflation.

4. Development and Non-Development Expenditure

The expenditure for the development of huge plants and projects will increase the

demand for factors of production resulting in inflation. On the other way, the expenditure

for the non-development like defense expenditure will create shortages of consumption

goods resulting inflation.

5. Indirect Taxes


Due to high indirect taxes, sellers increase the price of their products to recover the tax

from the consumers, which indirectly leads to inflation.

6. Demand for Foreign Commodities

When the demand for the foreign commodities increases, the supply for the home

commodities decreases which leads to increasing the price.

B) NON-MONETARY FACTORS

1. Rising Population

As population of the economy increases, demand for better goods increases, which

causes inflation. So, rising population is the foremost non-monetary factor resulting

inflation.

2. Natural Calamities

Due to the occurrence of natural calamities like floods, famines, bad weather, etc results

in crop failure, which leads to rising price.

3. Speculation and Black Money

Speculation, hoarding and black money also causes inflation, as such unearned money is

spend lavishly by people, creating unnecessary demand for goods and

services.

4. Unfair Practices by Monopoly Houses

The monopoly houses prefer to restrict outputs of their products and raise their prices to

enjoy excess profits leading to inflation.

5. Bottlenecks and Shortages

Bottlenecks i.e. blockages and shortages of various kinds destruct the process of the

economic development. As a result of shortages, price rise.


C) STRUCTURAL FACTORS

1. Capital Shortage

This is due to a very low rate of capital formation in a poor country where vicious circle

of poverty exists.

2. Infrastructural Bottlenecks

Power shortages, inefficient transport, underutilization of capacities and resources, etc

are obstruction to the economic growth of the country, which leads to the price rise and

finally inflation.

3. Limited Efficient Entrepreneurs

Entrepreneurs do not possess spirit to undertake risky projects. Investments are generally

made in trade and unproductive assets like land, gold etc. Hence when supply of money is

increased, output of real goods and services does not increase which leads to inflation.

4. Lack of Foreign Capital

The unfavourable terms of trade and deficit in balance of payments have further

increased the problem of rising prices.

5. Imperfections of the Market

Immobility of factors, rigid prices, ignorance of market conditions etc all these does not

allow the resources to utilize properly so rising prices due to increase in supply and

without increase in real output.


TRACE THE EFFECTSOF

INFLATION


2.1 Economic Effects of Inflation

Inflation is a very unpopular happening in an economy. Inflation is the most important

concern of the people as it badly affects their standard of living. Some America

presidential candidates called ‘Inflation As Enemy Number One’

High rate inflation makes the file of the poor very miserable. It is therefore described as

anti-poor. Inflation not only disrupts the economy but also prepares ground for social

and political upheavals.

The effects/consequences of inflation are as followers -

2.1.1. EFFECTS ON PRODUCTION

The condition or fact of being operative or in force on production can be divided into two

categories the stimulating or effect and the disastrous effect.

(A) Stimulating or Favourable Effect

Because of the effects on production it has been observed that mild inflation or gently

rising prices have a stimulating or a tonic effect on the economy. When price rise profits

increases, investment increases that generates income and creates employment as a

results output expands. This process continues up to the point of full employment

(B) Disastrous or Unfavourable Effects

If money supply increases beyond the point of full employment, it would lead to a

galloping or hyperinflation and results in disastrous effects on the economy.

[a] Uncontrolled inflation leads to discouragement in savings due to falling value of

money.

[b] Energies of business community are diverted to speculation and making quick profits

rather than genuine production i.e. encourages speculation.

[c] Inflation encourages the hoarding and black marketing

[d] Inflation also affects Misallocation of Resources


[e] Flight of capital is encouraged due to fall in money the investors prefer to invest

abroad.

[f] Consumers suffers as seller’s market will be developed if price of all type of goods

rise of any quality.

[g] Distortions and Maladjustments in the production dispute the working of the price

systems in the system in the economy.

2.1.2. EFFECTS OF INFLATION ON INCOME DISTRIBUTION

Inflation is socially undesirable. It redistributes wealth in favour of the rich at the cost of

poor it makes the rich richer and poor poorer. The people whose real incomes erode

during inflation are the victims of inflation.

[a] As the value of money falls the burdens of debt is reduced and debtors gain creditor

suffer because in real sense they receive less during inflation.

[b] Fixed income groups like salaried class and pensioners are hit hard during inflation.

[c] Business community welcomes inflation as they earn super normal profits.

[d] Investors in shares benefit during inflation small savers, small investors and class

lose during inflation.

[e] Farmers gain in inflation by prices of agriculture prices commodities rise and costs

paid them lag behind prices.

2.1.3. EFFECT OF INFLATION ON CONSUMPTION AND WELFARE

Inflation reduces the economic welfare of the fixed income groups as the price raises the

purchasing power of money falls hence the people get a smaller amount of goods services

or low quality for the same amount of money. As a result their consumption would fall

and the standard of living. Hence galloping inflation is the ‘Cruelest tax of all’.

2.1.4. EFFECTS OF INFLATION ON FOREIGN TRADE

Inflation affects adversely the Country’s balance of payments situation when prices are

raising foreign demand for our goods will fall and exports declined due to high prices


domestic consumers buy foreign goods and imports rise hence unfavourable balance of

payments.

2.1.5. SOCIAL AND POLITICAL EFFECTS

[a] The antisocial elements get rewarded and the masses suffer during inflation.

[b] Inflation disrupts social life by favouring rich and black market.

[c] The standard of business morality go down during inflation.

[d] People lose faith in democratic government due to inflation.

2.1.6. EFFECTS ON MANUFACTURERS

Inflation is harmful to trade. Manufacturers generally sell goods on credit. When they

seek repayment they find that the money they receive is less than they expected. They

therefore become reluctant to trade.


MEASURES TO

CONTROL INFLATION


These are the following actions taken to control inflation

1) Monetary Measures

2) Fiscal Measures

3) Other Non-monetary Measures

(1) MONETARY MEASURES

(A) Quantitative Methods

1. Raising the Bank Rate

To control inflation the central bank increases the bank rate. With this the cost of

borrowing of commercial banks from central bank will increase so the commercial banks

will charge higher rate of interest on loans. This discourages borrowings and thereby

helps to reduce the money in circulation.

2. Open Market Operations

During inflation, the central bank sells the bills and securities. These cash reserves of

commercial banks will decrease as they pay central bank for purchasing these securities.

Thus the loan able funds with commercial banks decrease which leads to credit

contraction.

3. Variable Reserve Ratio

The commercial banks have to keep certain percentage of their deposits with the central

bank in the form of cash reserve. During inflation, the central bank increases this cash

reserve ratio this will reduce the lending capacity of the banks.

(B) The Qualitative Methods

1. Fixation of Margin Requirements

Commercial banks have to maintain certain fixed margins while granting loans. In

inflation central bank raises the margin to contract credits and reduces the price level.

2. Regulation of Consumer Credit


For purchase of durable consumer goods on installment basis rules regarding payments

are fixed. During inflation and initial payment is increased and the number of

installments are reduced. These results in credit contraction and fall in prices.

3. Control through Directives

Certain directives are issued by central bank to commercial banks and they are asked to

follow them while lending. This keeps in check the volume of money.

4. Rationing of Credit

The central bank regulates the amount and purpose for which credit is granted by

commercial banks.

5. Moral Suasion

This refers to request made by central bank to commercial banks to follow its general

monetary policy.

6. Direct Action

Direct action is taken by central bank against commercial banks if they do not follow the

monetary policy laid by it.

7. Publicity

The central bank undertakes publicity to educate commercial bank and public about the

trends in money market. By undertaking these measures the central bank can control the

money supply and help to curb inflation.


(2) FISCAL MEASURES

1. Taxation

The rates of direct and indirect taxes may be raised and new taxes may be imposed. This

policy will reduce the disposable income in the hands of the people and their expenditure.

2. Public Expenditure

During inflation, the government should reduce its expenditure. This would reduce the

income in the hands of some people. Hence the effective demand would decrease.

3. Public Borrowing

The government may resort to voluntary and compulsory borrowing. This policy reduces

the income in the hands of some people. Hence the effective demand would decrease.

4. Over Valuation of Domestic Currency

Over valuation of domestic currency makes exports costlier and there is a fall in the

volume of exports. Imports also become cheaper and there is an increase in money

supply causing a fall in prices.

5. Inducement to Save

The government should induce savings through incentives. This will reduce the supply of

money and purchasing power of the people causing a fall in prices.

6. Public debt management

The public debt should be handled in such a way that there is no increase in the supply of

money. Hence the surplus in the budget should be used to repay the public debts.


(3) NON –MONETARY MEASURES/OTHER MEASURES

1. Increase in output

Every country suffering from inflation should take steps to increase the output of scarce

goods and services. The production of essential goods at the cost of luxury goods can

also serve as an anti-inflationary measure.

2. Price control and rationing

Price control must be introduced in respect of essential commodities. Also rationing

should be introduced for equitable distribution of essential commodities. The supply of

essential goods can be undertaken through public distribution system to keep the prices

in check.

3. Imports

Imports of food grains and other essential goods which are in short supply should be

allowed.

4. Legal action

Legal action should be taken against hoarders and black marketers.

5. Wage-rate

During inflation, the rise in wage rate should be linked to rise in labour productivity.

This will help to control inflation.

6. Check on population growth

It is essential to check the growth of population by adopting effective family planning

devices.


Above all, an efficient and honest administration and good discipline among people are

essential. The various measures stated above have to be combined in a proper manner

depending on the situation of the country.


PRICE RISE STILL

PINCHING COMMON MAN’S

POCKET


The 15 per cent rise in national and per capita income and a buoyant 9.4 per cent GDP

growth notwithstanding, the common man is still reeling under the massive burden of

rising prices.

In fact, excepting for just sugar, the rates of as many as 7-8 essential commodities have

shot up by over 25 per cent between January and May as against the same period last

year.

While the prices of wheat, pulses, spices and condiments, edible oil, meat & meat

products, milk products and fruits & vegetables – on an average – increased by over 25

per cent in this period, forcing the aam aadmi to question the authenticity of the much

promised inclusive growth.

The price rises come at a time when India has witnessed a growth of 15.8 per cent in

2006-07 in its national income from Rs 28,46,762 crore in 2005-06 to Rs 32,96,639 crore

in 2006-07.


The primary reason for their vegetables price rise is the entry of retailers in organised

market which has been sourcing supplies directly from the farmers to retail warehouses.


TACKLING INFLATION


Many people think it is ok to tolerate some inflation if, in return, it is possible to sustain

higher growth rates. Nothing matters as much for peace, prosperity and poverty

alleviation as high GDP growth. However, the link between inflation and growth is

complex. High inflation does not give high growth. The growth miracles of Asia, where

above 7% growth was sustained over a 25-year period, were not associated with high

inflation. In fact, countries with high inflation have tended to have low growth.

In the business cycle, an acceleration of inflation can support a temporary acceleration

of growth. In India, expected inflation has gone up from roughly 3% in 2004 to roughly

7% today--a rise of 4 percentage points.

Interest rates have risen by less than 4 percentage points. As a consequence, real interest

rates have actually gone down. Borrowing has become cheaper; we have a credit boom;

and this is giving heightened GDP growth.

If inflation now stands still at 7%, this boost to GDP growth will fade away. Episodes

where inflation went up are associated with a brief acceleration of GDP growth. A

government can jolt an economy by raising the inflation rate. This heightened growth is

not sustained. Conversely, achieving high sustained GDP growth is about fundamental

issues of economic reform, and does not concomitantly require high inflation.

One of the great strengths of India is that the political system just does not accept high

inflation. This is one area where politicians have been ahead of the intellectuals.

Inflation of 3% is politically acceptable, and inflation above 5% sets off alarm bells.

The government that can jolt an economy by raising the inflation rate then has to go

through the costly process of wringing out the inflation, to get back to 3%. Since there is

no trade-off between inflation and GDP growth, Parliament is right in demanding low

inflation and high GDP growth.


Currently, in India, we go through boom-and-bust cycles; sometimes GDP growth rates

are very high and sometimes GDP growth rates drop sharply. This boom-and-bust cycle

is unpleasant for every household. There is a powerful international consensus that

stabilizing inflation reduces this boomand- bust cycle of GDP growth.

The ideal combination, which has been achieved in all mature market economies, is one

involving low inflation, which is also predictable and nonvolatile. Low inflation volatility

induces low volatility of GDP growth.

Low and predictable inflation also reduces the number of mistakes made by

entrepreneurs in formulating investment plans. What India does not have is an

institutional capacity for delivering predictable, non-volatile inflation of 3%. In socialist

India, the way to deal with an outbreak of inflation was to do government interference in

commodity markets.

A few commodities that "cause" inflation are identified, and the government swings into

action banning exports, giving out import licences, banning futures trading, sending the

police to unearth "hoarding", etc.

This is deeply distortionary. Milk exports were banned, and milk prices fell. But why

should milk farmers pay for a macroeconomic problem of inflation? The cost of bringing

down inflation needs to be dispersed all across the economy.

If milk prices had been allowed to rise, then more labour and capital would shift from

unproductive cereals to high-value milk production. India has the potential to be the

world's biggest exporter of milk. But this requires a sophisticated web of producers,

supply chain, exporters, factories, etc.

This sophisticated ecosystem will not flourish when the government meddles in the milk

industry. A meddlesome government will go through the whiplash of doing an MSP one


day because milk prices are low and banning exports another day because milk prices

are high.

There is something profoundly wrong about a government that interferes in what can be

imported and what can be exported. If the export of ball bearings were sometimes banned

by the government, you can be sure there would be fewer factories to build ball bearings.

India is evolving from a socialist past into a mature market economy. How can

predictable, non-volatile inflation of 3% be achieved? The recipe that has been

developed worldwide is to devote the entire power of monetary policy to this one task. In

India, the RBI has a complex mandate spanning over many contradictory roles. This has

led to failures on inflation control.

In a mature market economy, a modern central bank watches expected inflation with

great interest. Active trading takes place on the spot and derivatives markets, for both

ordinary bonds and inflation-indexed bonds.

Using these prices, a modern central bank is able to infer expected inflation. When the

short-term interest rate is raised or lowered, in order to respond to changes in expected

inflation, there is a slow impact on the economy, possibly spread over two to three years.

A modern central bank has the economic knowledge required to watch out for expected

inflation deep in the future, and respond to it ahead of time, so as to deliver inflation that

is on target.

In India's case, the RBI Act of 1934 predates modern monetary economics. In other

countries, fundamental reforms have been undertaken in order to refashion monetary

institutions in the light of modern knowledge. As an example, in the late 1990s, when

Tony Blair and Gordon Brown won the election, they refashioned the Bank of England as

a focused central bank which has three core values


The bad drafting of the RBI Act of 1934 is the ultimate cause of the distress of milk

producers today. These linkages are not immediately visible, but they are very real. It is

because India does not have a proper institutional foundation for monetary policy that

we are reduced to distortionary mechanisms for inflation control.


MEASURESOF

INFLATION


Inflation is measured by calculating the percentage rate of change of a price index,

which is called the inflation rate. This rate can be calculated for many different price

indices, including Consumer price indices (CPIs) which measure the price of a selection

of goods purchased by a "typical consumer." In the UK, an alternative index called the

Retail Price Index (RPI) uses a slightly different market basket.

Cost-of-living indices (COLI) are indices similar to the CPI which are often used to

adjust fixed incomes and contractual incomes to maintain the real value of those

incomes.

Wholesale price index The Wholesale Price Index (WPI) is the most widely used price

index in India. It is the only general index capturing price movements in a comprehensive

way. WPI was first published in 1902, and was one of the more economic indicators

available to policy makers until it was replaced by most developed countries by the

Consumer Price Index in the 1970s.It is an indicator of movement in prices of

commodities in all trade and transactions.

Producer price indices (PPIs) which measure the prices received by producers. This

differs from the CPI in that price subsidization, profits, and taxes may cause the amount

received by the producer to differ from what the consumer paid. There is also typically a

delay between an increase in the PPI and any resulting increase in the CPI. Producer

price inflation measures the pressure being put on producers by the costs of their raw

materials. This could be" passed on" as consumer inflation, or it could be absorbed by

profits, or offset by increasing productivity. In India and the United States, an earlier

version of the PPI was called the Wholesale Price Index.

Commodity price indices, which measure the price of a selection of commodities. In the

present commodity price indices are weighted by the relative importance of the

components to the "all in" cost of an employee.


The GDP Deflator is a measure of the price of all the goods and services included in

Gross Domestic Product (GDP). The US Commerce Department publishes a deflator

series for US GDP, defined as its nominal GDP measure divided by its real GDP

measure.

Capital goods price Index, although so far no attempt at building such an index has been

made, several economists have recently pointed out the necessity of measuring capital

goods inflation (inflation in the price of stocks, real estate, and other assets) separately.

[citation needed] Indeed a given increase in the supply of money can lead to a rise in

inflation (consumption goods inflation) and or to a rise in capital goods price inflation.

The growth in money supply has remained fairly constant through since the 1970's

however consumption goods price inflation has been reduced because most of the

inflation has happened in the capital goods prices.

Regional Inflation

The Bureau of Labor Statistics breaks down CPI-U calculations down to different regions

of the US.

Historical Inflation

Before collecting consistent econometric data became standard for governments, and for

the purpose of comparing absolute, rather than relative standards of living, various

economists have calculated imputed inflation figures. Most inflation data before the early

20th century is imputed based on the known costs of goods, rather than compiled at the

time. It is also used to adjust for the differences in real standard of living for the presence

of technology. This is equivalent to not adjusting the composition of baskets over time.


INFLATION &

INDIA (WPI)


The Wholesale Price Index (WPI) is the most widely used price index in India. It is the

only general index capturing price movements in a comprehensive way. WPI was first

published in 1902, and was one of the more economic indicators available to policy

makers until it was replaced by most developed countries by the Consumer Price Index in

the 1970s.It is an indicator of movement in prices of commodities in all trade and

transactions. It is also the price index in India, which is available on a weekly basis with

the shortest possible time lag of two weeks. It is due to these attributes that it is widely

used in business and industry circles and in Government and is generally taken as an

indicator of the rate of inflation in the economy.

The current series of Index Number of Wholesale Prices in India with 1981- 82 as base

year came into existence from July 1989. With a view to reflecting adequately the

changes that have taken place in the economy since 1981-82, the Government appointed

a Working Group to revise the existing WPI series and to examine the commodity

coverage, selection of the base year, weighting diagram and other related issues. WPI is

the index that is used to measure the change in the average price level of goods traded in

wholesale market. The new series with 1993-94 as the base has as many as 435 items in

the Commodity basket. To reflect the structural changes in the economy that have taken

place over a decade, a large number of commodities have been added and a few with

diminished importance have been dropped. In the revised series, “Primary Articles”

contribute 98 items, “Fuel, Power, Light and Lubricants” 19 items, and “Manufactured

Products” provide 318 items. The number of price quotations in the revised series is

spread out to as many as 1918 quotations. In all, there are 136 new items in the revised

series. Out of that, Primary Articles account for 13, Fuel Group contributes 1 and

Manufactured Products have 122 new commodities. The revised weights of the three

major groups are given below. Figures in the parentheses are the weights of the

respective groups in the 1981-82 series.

Primary Articles

Fuel, Power, Light & Lubricants

Manufactured Products


India uses the Wholesale Price Index (WPI) to calculate and then decide the inflation

rate in the economy. Most developed countries use the Consumer Price Index (CPI) to

calculate inflation.

Annual rates of change in the WPI calculated using both the existing and the new series

are given below. It is seen that the new series starts at a higher level than the old series

accounting for a relatively higher annual rate of change, but thereafter the two series

virtually move in cycle.

Main constituents of WPI

1. Primary articles

2. Fuel, power

3. Manufactured products

4. Food articles

5. Vegetables

6. Food products

7. Edible oils

8. Cement

Criteria for Selection of Wholesale Price Outlets

The following criteria were used to determine the wholesale price outlets

1. Popularity of an establishment along the line of goods to be priced

2. Consistency of the stock

3. Permanency of the outlet

4. Cooperativeness of the price informant

5. Location

Measures of inflation in India

Three different price indices are available in India

1. Wholesale price index

2. Consumer price index [calculated for 3 different types of workers]


3. GDP deflator

Availability

1. The WPI is available weekly [for a lag of 2 weeks]

2. The CPI is available monthly [for a log of 1 month]

3. The GDP deflator is available annually

In many countries, the main focus is placed on CPI for assessing inflationary trends,

because

1. It is the index most statistical resources are placed

2. It is most closely related to the cost of living

In India however the main focus is placed on WPI because it has a broader coverage and

is published on a more frequent and timely basis than the CPI.

However, the CPI remains important because it is used for indexation purposes for many

wage and salary earners.


INDIAN

SCENARIO


Inflation is no stranger to the Indian economy. In fact, till the early nineties Indians were

used to double-digit inflation and its attendant consequences. But, since the mid-nineties

controlling inflation has become a priority for policy framers.

The natural fallout of this has been that we, as a nation, have become virtually intolerant

to inflation. While inflation till the early nineties was primarily caused by domestic

factors (supply usually was unable to meet demand, resulting in the classical definition of

inflation of too much money chasing too few goods), today the situation has changed

significantly.

Inflation today is caused more by global rather than by domestic factors. Naturally, as

the Indian economy undergoes structural changes, the causes of domestic inflation too

have undergone tectonic changes.

Needless to emphasise, causes of today's inflation are complicated. However, it is indeed

intriguing that the policy response even to this day unfortunately has been fixated on the

traditional anti-inflation instruments of the pre-liberalisation era.

Reasons for inflation in India

1) Increase in Demand and fall in supply causes rise in prices.

2) A Growing Economy has to pass through Inflation.

3) Lack of Competition and Advanced Technology (increases cost of production and rise

in price)

4) Defective Monetary and Fiscal Policy (In India its fine)

5) Hoarding (when traders hoard goods with intention to sell later at high prices)

6) Weak Public Distribution System


INFLATION PRESSURE OVER THE LAST FEW MONTHS


INFLATION IN INDIA AND OTHER DEVELOPED COUNTRIES


INFLATION DURING 1980’s AND 1990’s

WPI inflation was relatively stable between 1983 and 1990, averaging 6 ¾ percent,

recording a low of 3 percent in early 1986, and a high of a little over 10 percent in 1988.

In the 1990s, inflation has, on average, been higher at 8 ¾ percent, and considerably

more variable. Inflation rose sharply in the early 1990s, reaching a peak of a little over

16 percent in late 1991, as primary product prices rose sharply and the balance of

payment crisis resulted in a sharp depreciation of the rupee and upward pressure on the

price of industrial inputs. However, as the agricultural sector rebounded, industrial

activity slowed, and financial stability was restored, inflation declined to 7 percent by

mid 1993 but then again accelerated to over 10 percent during 1994 and 1995 as

economic activity recovered strongly. In response, the RBI moved to tighten monetary

policy, and inflation was brought down gradually, reaching a low of 3 ¾ percent in mid

1997.However, more recently, inflation again accelerated in the second half of 1998as

adverse supply conditions in key commodity markets put upward pressure on food price.

As these conditions have eased, inflation has again fallen sharply.


Within the three sub-component of WPI, prices in the manufacturing sector have been

lowered and more stable, ranging from 2-13 percent. Inflation in both primary products

and fuel and energy categories has been considerably high in1990s than in the 1980s.

Both indices have also volatile. Within the fuel and energy category, the sharp rise in

prices in the recent year is partly due to government moving more towards market based

prices, although given the administered nature of these prices such adjustment have


tended to occur at irregular intervals leading to sharp movements in the index.


GLOBAL INFLATION A COMPARISON WITH INDIA

Inflation rates in some developed and developing economies based on the Consumer

Price Indices. Up to the mid 1990s, while inflation rate in the developed economies

ranged between 1-2 percent, it was in a much higher range for the developing economies

including India - with some years even recording double digit inflation. For exchange

rate stability and smoother trade, it is imperative that inflation rate in India be close to

our major trading partners. Over the last three to four years, we have moved closer to

this objective with inflation rate being in the range 3-5 percent as against 2-3 percent in

the developed economies. The declining trend in inflation is also visible in many of the

developing economies in Asia.


ISSUES IN

MEASURING INFLATION


Measuring inflation requires finding objective ways of separating out changes in nominal

prices from other influences related to real activity. In the simplest possible case, if the

price of a 10 kgs of corn changes from 90 to 100 over the course of a year, with no

change in quality, then this price change represents inflation. But we are usually more

interested in knowing how the overall cost of living changes, and therefore instead of

looking at the change in price of one good, we want to know how the price of a large

'basket' of goods and services changes. This is the purpose of looking at a price index,

which is a weighted average of many prices. The weights in the Consumer Price Index,

for example, represent the fraction of spending that typical consumers spend on each type

of goods (using data collected by surveying households).

Inflation measures are often modified over time, either for the relative weight of goods in

the basket, or in the way in which goods from the present are compared with goods from

the past. This includes hedonic adjustments and “reweighing” as well as using chained

measures of inflation. As with many economic numbers, inflation numbers are often

seasonally adjusted in order to differentiate expected cyclical cost increases, versus

changes in the economy.

Inflation numbers are averaged or otherwise subjected to statistical techniques in order

to remove statistical noise and volatility of individual prices. Finally, when looking at

inflation, economic institutions sometimes only look at subsets or special indices. One

common set is inflation excluding food and energy, which is often called “core inflation”.


AN EXAMPLE OF HOW INFLATION CAN BE DANGEROUS

Hazards of inflation [How Zimbabwe was affected by inflation] Have you heard of a

country which is dotted with malls filled with goods, but no customers? It is Zimbabwe,

the land of Mugabe.

Zimbabwe is a classic case of how inflation can make life hell for people. Experts say it

all started with Mugabe’s regime. Whatever may be the reason, the basic flaw in

Zimbabwe’s economy is that Zimbabwe lost its ability to feed itself.

So, if you don’t have enough agriculture commodities the prices are bound to go up. This

is one lesson India can learn from Zimbabwe. India’s wheat, rice, pulses and edible oil

production is not enough to keep pace with the growth the country is witnessing. That is

why Indian government is worrying about the rising inflation rates.

However, it is not anywhere near Zimbabwe. Zimbabwe’s skyrocketing inflation – now

the world’s highest, running at more than 100,000 per cent a year – keeps the cost of

living rising.

In 1979, when Mugabe’s nationalist rebels overthrew the white dominated government of

Rhodesia, and changed the name of the country to Zimbabwe, thousands of commercial

farms managed to grow enough food to export throughout the region.

At present, more than a decade of mismanagement and neglect has dropped agricultural

production to pre-colonial levels. This year, Zimbabwe’s shortfall in maize is 360,000

tones, and its shortfall in wheat is 255,000 tones.

Streets of Zimbabwe are dotted with shopping mall. That shows that there is food on the

shelves, but all of it highly priced. Massive department stores, built for a time when

farmers from miles around would come to do their weekend shopping, are full of clothes,

but without customers.


With cash almost a worthless possession, people have started investing in something

different. They stack bags of maize meal in their homes.

The situation in Zimbabwe has hit several Indians badly. Many of the Indian businessmen

in Zimbabwe, especially Gujaratis, are finding it tough to do trade there.

Because, a sausage sandwich sells for 30 million Zimbabwe dollars, or about US $1.25.

A 30-pound bag of potatoes cost 90 million in the first week of March. Now that same

bag costs 160 million.

So, Zimbabwe is an example for the world how inflation can ruin a country, which does

not produce enough food for itself.


RESERVE BANKOF

INDIA


The central bank of the country is the Reserve Bank of India (RBI). It was established in

April 1935 with a share capital of Rs. 5 crores on the basis of the recommendations of the

Hilton Young Commission. The share capital was divided into shares of Rs. 100 each

fully paid which was entirely owned by private shareholders in the beginning. The

Government held shares of nominal value of Rs. 2,20,000.

Reserve Bank of India was nationalized in the year 1949. The general superintendence

and direction of the Bank is entrusted to Central Board of Directors of 20 members, the

Governor and four Deputy Governors, one Government official from the Ministry of

Finance, ten nominated Directors by the Government to give representation to important

elements in the economic life of the country, and four nominated Directors by the Central

Government to represent the four local Boards with the headquarters at Mumbai,

Kolkata, Chennai and New Delhi. Local Boards consist of five members each Central

Government appointed for a term of four years to represent territorial and economic

interests and the interests of co-operative and indigenous banks.

The Reserve Bank of India Act, 1934 was commenced on April 1, 1935. The Act, 1934 (II

of 1934) provides the statutory basis of the functioning of the bank.

The Bank was constituted for the need of following

To regulate the issue of bank notes

To maintain reserves with a view to securing monetary stability and

To operate the credit and currency system of the country to its advantage.


Functions of Reserve Bank of India:

To maintain monetary stability so that the business and economic life can deliver

welfare gains of a properly functioning mixed economy.

To maintain financial stability and ensure sound financial institution so that

monetary stability can be safely pursued and economic units can conduct their

business with confidence.

To maintain stable payments system so that financial transactions can be safely and

efficiently executed.

To promote the development of financial infrastructure of markets and systems, and

to enable it to operate efficiently i.e., to play a leading role in developing a sound

financial system so that it can discharge its regulatory function efficiently.

To ensure that credit allocation by the financial system broadly reflects the national

economic priorities and societal concerns.


ROLE OF RBI

The Reserve Bank of India Act of 1934 entrust all the important functions of a central

bank the Reserve Bank of India.

1. Bank of Issue

Under Section 22 of the Reserve Bank of India Act, the Bank has the sole right to issue

bank notes of all denominations. The distribution of one rupee notes and coins and small

coins all over the country is undertaken by the Reserve Bank as agent of the Government.

The Reserve Bank has a separate Issue Department which is entrusted with the issue of

currency notes. The assets and liabilities of the Issue Department are kept separate from

those of the Banking Department. Originally, the assets of the Issue Department were to

consist of not less than two-fifths of gold coin, gold bullion or sterling securities provided

the amount of gold was not less than Rs. 40 crores in value. The remaining three-fifths of

the assets might be held in rupee coins, Government of India rupee securities, eligible

bills of exchange and promissory notes payable in India. Due to the exigencies of the

Second World War and the post-war period, these provisions were considerably

modified. Since 1957, the Reserve Bank of India is required to maintain gold and foreign

exchange reserves of Ra. 200 crores, of which at least Rs. 115 crores should be in gold.

The system as it exists today is known as the minimum reserve system.

2. Banker to Government

The second important function of the Reserve Bank of India is to act as Government

banker, agent and adviser. The Reserve Bank is agent of Central Government and of all

State Governments in India excepting that of Jammu and Kashmir. The Reserve Bank has

the obligation to transact Government business, via. to keep the cash balances as

deposits free of interest, to receive and to make payments on behalf of the Government

and to carry out their exchange remittances and other banking operations. The Reserve

Bank of India helps the Government - both the Union and the States to float new loans

and to manage public debt. The Bank makes ways and means advances to the

Governments for 90 days. It makes loans and advances to the States and local

authorities. It acts as adviser to the Government on all monetary and banking matters.


3. Bankers' Bank and Lender of the Last Resort

The Reserve Bank of India acts as the bankers' bank. According to the provisions of the

Banking Companies Act of 1949, every scheduled bank was required to maintain with the

Reserve Bank a cash balance equivalent to 5% of its demand liabilities and 2 per cent of

its time liabilities in India. By an amendment of 1962, the distinction between demand

and time liabilities was abolished and banks have been asked to keep cash reserves equal

to 3 per cent of their aggregate deposit liabilities. The minimum cash requirements can

be changed by the Reserve Bank of India.

The scheduled banks can borrow from the Reserve Bank of India on the basis of eligible

securities or get financial accommodation in times of need or stringency by rediscounting

bills of exchange. Since commercial banks can always expect the Reserve Bank of India

to come to their help in times of banking crisis the Reserve Bank becomes not only the

banker's bank but also the lender of the last resort.

4. Controller of Credit

The Reserve Bank of India is the controller of credit i.e. it has the power to influence the

volume of credit created by banks in India. It can do so through changing the Bank rate

or through open market operations. According to the Banking Regulation Act of 1949,

the Reserve Bank of India can ask any particular bank or the whole banking system not to

lend to particular groups or persons on the basis of certain types of securities. Since

1956, selective controls of credit are increasingly being used by the Reserve Bank.

The Reserve Bank of India is armed with many more powers to control the Indian money

market. Every bank has to get a licence from the Reserve Bank of India to do banking

business within India, the licence can be cancelled by the Reserve Bank of certain

stipulated conditions are not fulfilled. Every bank will have to get the permission of the

Reserve Bank before it can open a new branch. Each scheduled bank must send a weekly

return to the Reserve Bank showing, in detail, its assets and liabilities. This power of the

Bank to call for information is also intended to give it effective control of the credit

system.


The Reserve Bank has also the power to inspect the accounts of any commercial bank.

As supreme banking authority in the country, the Reserve Bank of India, therefore, has

the following powers

(a) It holds the cash reserves of all the scheduled banks.

(b) It controls the credit operations of banks through quantitative and qualitative

controls.

(c) It controls the banking system through the system of licensing, inspection and calling

for information.

(d) It acts as the lender of the last resort by providing rediscount facilities to scheduled

banks.

5. Custodian of Foreign Reserves

The Reserve Bank of India has the responsibility to maintain the official rate of exchange.

According to the Reserve Bank of India Act of 1934, the Bank was required to buy and

sell at fixed rates any amount of sterling in lots of not less than Rs. 10,000. The rate of

exchange fixed was Re. 1 = sh. 6d. Since 1935 the Bank was able to maintain the

exchange rate fixed at lsh.6d. though there were periods of extreme pressure in favour of

or against the rupee. After India became a member of the International Monetary Fund

in 1946, the Reserve Bank has the responsibility of maintaining fixed exchange rates with

all other member countries of the I.M.F.

Besides maintaining the rate of exchange of the rupee, the Reserve Bank has to act as the

custodian of India's reserve of international currencies. The vast sterling balances were

acquired and managed by the Bank. Further, the RBI has the responsibility of

administering the exchange controls of the country.

6. Supervisory functions

In addition to its traditional central banking functions, the Reserve bank has certain non-

monetary functions of the nature of supervision of banks and promotion of sound banking

in India. The Reserve Bank Act, 1934, and the Banking Regulation Act, 1949 have given

the RBI wide powers of supervision and control over commercial and co-operative banks,


relating to licensing and establishments, branch expansion, liquidity of their assets,

management and methods of working, amalgamation, reconstruction, and liquidation.

The RBI is authorized to carry out periodical inspections of the banks and to call for

returns and necessary information from them. The nationalization of 14 major Indian

scheduled banks in July 1969 has imposed new responsibilities on the RBI for directing

the growth of banking and credit policies towards more rapid development of the

economy and realization of certain desired social objectives. The supervisory functions of

the RBI have helped a great deal in improving the standard of banking in India to

develop on sound lines and to improve the methods of their operation.

7. Promotional functions

With economic growth assuming a new urgency since Independence, the range of the

Reserve Bank's functions has steadily widened. The Bank now performs a variety of

developmental and promotional functions, which, at one time, were regarded as outside

the normal scope of central banking. The Reserve Bank was asked to promote banking

habit, extend banking facilities to rural and semi-urban areas, and establish and promote

new specialized financing agencies. Accordingly, the Reserve Bank has helped in the

setting up of the IFCI and the SFC; it set up the Deposit Insurance Corporation in 1962,

the Unit Trust of India in 1964, the Industrial Development Bank of India also in 1964,

the Agricultural Refinance Corporation of India in 1963 and the Industrial

Reconstruction Corporation of India in 1972. These institutions were set up directly or

indirectly by the Reserve Bank to promote saving habit and to mobilize savings, and to

provide industrial finance as well as agricultural finance. As far back as 1935, the

Reserve Bank of India set up the Agricultural Credit Department to provide agricultural

credit. But only since 1951 the Bank's role in this field has become extremely important.

The Bank has developed the co-operative credit movement to encourage saving, to

eliminate moneylenders from the villages and to route its short term credit to agriculture.

The RBI has set up the Agricultural Refinance and Development Corporation to provide

long-term finance to farmers.


CONTROL MEASURES OF RBI

RBI actually has four chief weapons in its arsenal to control the inflation. They

are

1. Open Market Operations (OMO)

2. Reserve Requirements (CRR and SLR)

3. Bank Rate or Discount rate

4. Repo rate

1. Open Market Operations (OMO)

In this case RBI sells or buys government securities in open market transaction

depending upon whether it wants to increase the liquidity or reduce it. So when RBI sells

government securities in secondary market it sucks out the liquidity (stock of money) in

the economy. So overall it reduces the money supply available with banks in effect the

capital available with banks for lending purpose becomes scarce hence interest rates

move in upward direction. Exactly opposite happens when RBI buys securities from open

market. The transaction increases the money supply available with banks so the cost of

money (interest rate) moves in downward direction and business activities like new

investments, capacity expansion gets boost. In a nutshell RBI buys securities when the

economy is sluggish and demand is not picking up and sells securities when the economy

is overheated and needs to cool down.

OMO is also used in curbing the artificial liquidity created to avoid strengthening of

rupee against dollar in order to remain competitive in exports.

2. Reserve Requirements

This mainly constitute of Cash to Reserve Ratio (CRR) and Statutory Liquidity ratio

(SLR). CRR is the portion of deposits (as cash) which banks have to keep/maintain with

the RBI. This serves two purposes firstly, it ensures that a portion of bank deposits is

totally risk-free and secondly it enables that RBI control liquidity in the system, and


thereby, inflation. Whereas SLR is the portion of their deposits banks are required to

invest in government securities. So due to CRR and SLR obligation towards RBI financial

institutions will be able to lend only the part of money available with them although this

effect is small when transaction is between just two entities and constitute one layer.

But when money flows through series of players and layers very less money will be left

with the institutions present at the bottom of pyramid. So higher is the CRR less is the

money available in the economy. So interest rates will move in upward direction and

opposite happens when CRR is reduced. Recently RBI raised CRR from 4.5% to 5% in

two stages which enabled to transfer about 8000 Crore rupees from money in supply to

RBI’s coffers. CRR has actually been reduced to this level of 5% from 15% in 1981.

3. Bank Rate or Discount rate

This is the rate at which the RBI makes very short term loans to banks. Banks borrow

from the RBI to meet any shortfall in their reserves. An increase in the discount rate

means the RBI wants to slow the pace of growth to reduce inflation. A cut means that the

RBI wants the economy to grow and take up new ventures. Indian bank rate is at 6 per

cent down from 10 per cent in 1981 and 12 per cent in 1991

4. Repo rate

It is the rate at which the RBI borrows short term money from the market. After economic

reforms RBI started borrowing at market prevailing rates. So it makes more sense to

banks to lend money to RBI at competitive rate with no risk at all. Although the repo rate

transactions are for very short duration the everyday quantum of operations is

approximately Rs 40,000 crore everyday. Thus, large amount of capital is not available

for circulation. With increase in repo rate banks tend to invest more in repo transactions.

Open market operations have limitations due to amount of government securities with

RBI is limited and close to Rs 60,000 Crore and out of that only Rs 45,000 Crore is in

form of marketable securities. Considering Bank Rate which is untouched in current


scenario RBI is left with only 2 major measures viz. CRR and Repo Rate in its armory to

guard against the onslaught of inflation.

Since large part of inflation is attributed to large increase in international oil and metal

prices, the cooling price trend in them comes as a great relief to RBI and Indian economy

as a whole and along with RBI measures has helped stabilize inflation


MONETARY POLICY

The Reserve bank of India, being primarily concerned with money matters, so organize

currency and credit that it subs serves the broad economic objectives of the country. In

the performance of this task, it formulates and executes a monetary policy with clear cut

goals and tools to be used for this.

Meaning and objectives

Monetary policy, also described as money and credit policy, itself with the supply of

money as also credit to the economy. This is a statement, announced twice in a year. With

decline in the share of agricultural credit, and a rise in that of a industrial credit, the RBI

has started making an annual policy statement in April with a review of the same in

October Beginning with 1999-2000 The RBI has decided that the policy announcement

will be an annual affair.

The policy statement gives an overview of the working of the economy. In the light it

specifies the measures that the RBI intends to take an influence such key factors of money

supply, interest rate and inflation so as to ensure price stability. It also lays down norms

for financial institutions (like banks, finance companies etc.) governed by the RBI. There

pertain to such matters as cash reserves ratio, capital adequacy etc. in short, it is a sort

of blue-print containing a description of aims and means.

Two set of objective have been pursued for long. One is controlled expansion of money. It

sought to achieve the twin objectives of meeting in the full needs of production and

trade, and at the same time moderating the growth of money supply to contain the

inflationary pressure in the economy.

Second is sect oral deployment of the funds depending upon the priorities lay down in the

plant, the RBI as determined the allocation of funds also the interest rate among the

different sector. The sector which have received special attention are; core industries


(coal, iron, steel and engineering etc); food grains (rice, wheat); priority sector

(agriculture, small scale industries etc); and weaker section of population.

During the 1990s, and since then, while the growth of the economy remains the primary

aim, the control of inflation as become more urgent concern of the policy the thrust of the

policy as been restrictive in nature so as to reduce the fast growing money supply. The

aim as been to bring down the high double-digit inflation aimed at achieving the trend

rate of inflation at about 5%. The stipulated growth in money supply was put at an

average of 11% to 12% per annum. And the projected growth the rate of the economy

was set at 5% to 6%. The ninth plan as envisaged an average inflation rate in the region

of 7% per annum .The growth of money supply at 16 % the growth rate of economy is

6.5% other important concern of the policy as been deployment of funds as among

sectors such as procurement of food grains by the government, priority sectors and

export. The monetary policy, with its various aims, is to supplement the process of

macro-stabilization and structural adjustment intimated in the middle of 1991.

Monetary Policy of RBI

Reserve Bank of India focuses on the following main six basic goals of monetary policy

High employment

Economic growth

Price stability

Interest-rate stability

Stability of financial markets

Stability in foreign exchange markets

Limitation of Monetary Policy

While examining the working of the monetary policy. It is important remember that there

are some limitations on its successful application. These limitations on its successful

application. These limitation mostly arise from the under developed character of the

economy, as also from certain shortcomings of the economic situation obtaining in the

country.


1. Restricted scope of policy

The first thing to be aware of is that the policy relating to money is not all that is needed

to combat every evil, not even every monetary problem.

Every economic problem has diagnosed and tackled from all the angles including the

monetary side if the situation so demands. For example the price situation prevailing in

the country is not solely or the case of inflationary rise in price, where money seems to be

a major factor it needs to be stressed that monetary policy can at best influence the

demand for goods. For an effective use of the policy to flight inflation much larger policy

profile is necessary.

Correctly I.G.Patel states “… the role of monetary policy in combating inflation in any

country is strictly limited and that monetary policy can be effective only if it is a part of

an overall frame work of policy which includes not only fiscal and foreign exchange

policy but also what is described as income policy”

2. Predominance of currency

In the context of Indian conditioned a limitation on the effective use of currency in the

total money supply. The fact inhibits the credit-creating capacity of the banking system.

And since the reserve bank operates on money supply via credit to the public, its capacity

to do so is accordingly limited. With currency forming a large proportion of money

supply, banks have to face the problem of large outgo of currency every time they create

credit. By habit and custom associated with the paucity and backwardness of appropriate

institution people prefer to make use of cash rather than cheques. This means that a

major portion of the cash generally percolates in the economy without returning to the

banking system in the form of deposits. This reduces the capacity of the banking system to

create fresh credits on the basis of an increase in its reserves.

However it needs also to be noted that in recent years. The effectiveness of the monetary

policy is on its increase. This is largely because of the larger use of credit and the

consequent relative decline of currency in the total money supply, resulting from the


increase in the diversification of the economy and growth investment and organized

money markets. The last being aided by the reserve bank.

3. Underdeveloped money market

Another inhibiting factor in the Indian situation is the weak money market. This market

essentially dealing in short-term funds, is in fact cut into two with not much

communication between them and therefore with divergence in the structure of interest

rates. One part where the monetary policy is more effective is the organized one

consisting of Reserve bank, the state bank foreign banks, the Indian joint-stock banks etc

the other part, which is unorganized and less amenable to the operation of reserve bank

consist of heterogeneous agencies, known as “indigenous bank” these and other non-

banking institutions provide a considerable proportion of total credit and worse, the

linkage between the two sectors are not so well developed.

In this regard, too, things are improving with the further expansion of organized market

and a large number of indigenous bankers associating with modern institutions including

reserve bank uniform ally over a large part is being witnessed.

4. Existence of black money

A serious obstacle in the efficient working of monetary policy circulation of large amount

in the bank market. The transactions i.e. borrowers and lenders keep their transaction

secret. As such these are not reported the result is that supply and demand of money does

not remain as desired RBI. This means that a significant part of money economy remains

outside the orbit of RBI’s monetary policy it is rightly regarded “as a threat to the ability

of the official monetary-credit policy mechanism to manage demand and price in several

sectors of the economy.

5. Government policies

The scope of monetary policy is further restricted because the RBI could not pursue

independent line in money affairs the expansion of money supply has for example not

always need in the response of genuine needs of the economy .the creation of new money


to meet the government deficits is one such case it has been one powerful factor causing

inflationary pressures in the economy again in the development of credit among different

use for example purchase of government securities through the instrument of Statutory

Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR) further a considerable proportion

of as much as 40 percent of bank credit is required to be extended to the activities

specified under the scheme of priority sectors. So is to case of interest rates which have

been influenced more by the government policy rather than the RBI’s wishes. The rate of

interest in respect of specified loans. In fact it leads to a distortion of interest –structure

as the banks tried to make up for this by charging higher rates from the borrowers.

The enumeration of the main limitation on the monetary policy in India should be enough

for us to realize that this policy, even within its restricted sphere, is not the effective

remedy for problems essentially monetary in character. With in development and

diversification of the economy as also with the furtherance of banking habits things are

bound to improve.

However, in the meantime and alongside there is a need to modernize the money market,

which can be the basis for an effective monetary policy.


MONETARY & CREDIT POLICY

Monetary and Credit policy has direct impact on prices of commodities, inflation and

prevailing interest rates, hence, the growth of overall Indian economy. After the

economic reforms started in early nineties, although the interest rate determination is

market based, credit policy of RBI determines the direction of movement of interest rates.

Thus help RBI control the inflation.

Apart from this it also contains norms for the banking and financial sector and the

institutions which are governed by RBI like Banks, financial institutions, non-banking

financial institutions, primary dealers (money markets) and dealers in the foreign

exchange (forex) market. It also contains an economic overview and presents future

forecasts. The objective of the policy is to maintain price stability and ensure adequate

flow of credit to the productive sectors of the economy. Stability for the national currency

and growth in employment and income are also considered.

Credit policy of RBI

Annual Credit Policy RBI keeps all rates intact. In its credit policy for 2007-08, the

Reserve Bank of India has kept all the interest rates unchanged to sustain the investment

boom.

The RBI has lowered its growth forecast to 8.5 per cent from 8.5-9 per cent as it expects

global GDP to decline in 2007. Inflation targets have also been revised downward to 5

per cent from last year's targets of 5-5.5 per cent and RBI's medium term inflationary

target is now 4-4.5 per cent.

The RBI has also announced important operational tools for moving towards capital

account convertibility. Among them Indian companies can invest in foreign companies’

upto 300 per cent of their net worth, hedging for individuals and remittances up to

$100,000 v/s. USD 50,000 earlier.


Domestic producers and users will also be allowed to hedge their price risk on

international commodity exchanges for copper, aluminium, zinc, and even aviation

turbine fuel. Indian companies will also be allowed to rebook and cancel their forward

contracts.

Highlights RBI Monetary and Credit Policy

Following are the highlights of the Monetary and Credit Policy that the

Reserve Bank of India

RBI hikes CRR by 0.25 per cent from May 24;

Repo, Reverse Repo, Bank Rates unchanged.

RBI projects economy to grow by 8-8.5 per cent in 2008-09;

Inflation to be brought down to around 5.5 per cent in 2008-09 with a preference for

bringing it close to 5.0 per cent as soon as possible. Going forward, the resolve is to

condition policy and perceptions for inflation in the range of 4.0-4.5 per cent so that

an inflation rate of around 3.0 per cent becomes a medium-term objective.

High priority to price stability, well-anchored inflation expectations and orderly

conditions in financial markets while sustaining the growth momentum.

Swift response on a continuous basis to evolving adverse international and domestic

developments through both conventional and unconventional measures.

Emphasis on credit quality and credit delivery while pursuing financial inclusion.

Scheduled banks required to maintain CRR of 8.25 per cent with effect from the

fortnight beginning May 24, 2008.

M3 expansion to be moderated in the range of 16.5-17.0 per cent during 2008-09.

Deposits projected to increase by around 17.0 per cent or Rs 5,50,000 crore (Rs

5,500 billion) during 2008-09.

Adjusted non-food credit projected to increase by around 20.0 per cent during 2008-

09.

Introduction of STRIPS in Government securities by the end of 2008- 09.

A clearing and settlement arrangement for OTC rupee derivatives proposed.


Domestic crude oil refining companies would be permitted to hedge their commodity

price risk on overseas exchanges/markets on domestic purchase of crude oil and sale

of petroleum products based on underlying contract.

Currency futures to be introduced in eligible exchanges in consultation with the

SEBI; broad framework to be finalized by May 2008.

Indian companies to be allowed to invest overseas in energy and natural resources

sectors.

Reserve Bank can be approached for capitalization of export proceeds beyond the

prescribed period of realization.

Loans granted to RRBs for on lending to agriculture and allied activities to be

classified as indirect finance to agriculture.

The shortfall in lending to weaker sections would be taken into account for

contribution to RIDF with effect from April 2009.

RRBs allowed selling loan assets to other banks in excess of their prescribed priority

sector exposure.

The Reserve Bank to disseminate details of various charges levied by banks.

Asset classification norms for credit to infrastructure projects relaxed.

The prudential guidelines for specific off-balance sheet exposures of banks to be

reviewed.

Reserve Bank to carry out supervisory review of banks' exposure to the commodity

sector.

The limit of bank loans to individuals for housing having lower risk weight of 50 per

cent enhanced from Rs. 20 lakh to Rs. 30 lakh.

Consolidated supervision of financial conglomerates proposed.

Working Group to be set up for a supervisory framework for SPVs/Trusts.

Inter-departmental Group to review the existing regulatory and supervisory

framework for overseas operations of Indian banks.

All transactions of Rs. one crore and above made mandatory to be routed through the

electronic payment mechanism.

Dispense with the extant eligibility norms for opening on-site ATMs for well-managed

and financially sound UCBs.


Regulations in respect of capital adequacy, liquidity and disclosure norms for

systemically important NBFCs to be reviewed

RBI Credit Policy Refocusing on Inflation

The RBI has raised both the repo and the reverse repo rates by 25 basis points and most

analysts expect further hikes over the next year. Does this mean that the era of benign

interest rates are over? Central banks all over the world are generally fixated on

controlling inflation, even at the cost of economic growth. The US Fed is famous (or

notorious, depending which side you are on), for its obsession with inflation control and

has often been accused of pushing the economy to phases of lower growth through its

hawkish interest rate policies. The RBI, as befitting the central bank of a developing

country starved of economic growth, has traditionally given more importance to growth.

The latest credit policy review came after some optimistic statements from the finance

ministry on inflation and the need to keep interest rates low for sustaining the growth

momentum. The finance minister was less convinced about the need for a rate hike as he

stated publicly that inflation was within manageable limits. The finance ministry was of

the opinion that the effect of high oil prices had more or less been absorbed.

Going by the language of the mid-term review announced, the RBI clearly differs with the

government on both inflation and the impact of oil price. The central bank believes that

higher oil prices, considered a temporary phenomenon in early reports, have become a

more permanent component in inflation management. The RBI is also of opinion that the

pass-through effect of higher oil prices are not fully reflected in the prices of intermediate

and final goods. Hence, the central bank seems to have decided to focus more on

inflation rather than growth.

The RBI clearly admits that it would be difficult to keep year end inflation at the targeted

5 to 5.5 per cent without necessary policy responses. Hence, it has decided to act ahead

of the problem. As a deputy governor of the bank put it, inflation is like toothpaste – once

you let it ooze out, it is very difficult to push back.


As expected, the RBI raised the reverse repo rate, the rate at which it borrows money

from the system, by 25 basis points taking it to 5.25 per cent. The repo rate, the rate at

which the RBI lends money to the system, has also been raised by a matching margin to

6.25 per cent. The second move was not as widely expected as the first and is being seen

as a sign of this new found aggressiveness.

To prevent the market from reading too much into the hikes in repo and reverse repo

rates, the RBI has left both the bank rate and cash reserve ratio (CRR) unchanged. The

bank rate, currently at 6 per cent, is a token or signaling rate which does not have any

operational significance. However, it has some psychological significance as it is used as

a reference rate indicating the medium term interest outlook of the central bank. By

keeping the bank rate stable, the RBI is allowing itself the flexibility to roll back if

economic growth is affected in future.


CONCLUSION

Inflation is not simply a matter of rising prices. There are endemic and perhaps diverse

reasons at the root of inflation. Cost-push inflation is a result of decreased aggregate

supply as well as increased costs of production, itself a result of different factors. The

increase in aggregate supply causing demand-pull inflation can be the result of many

factors, including increases in government spending and depreciation of the local

exchange rate. If an economy identifies what type of inflation is occurring (cost-push or

demand pull), then the economy may be better able to rectify (if necessary) rising prices

and the loss of purchasing power.

Inflation is just like a man whose behaviour cannot be predicted and one can say that as

man has two faces, similarly Inflation can also be said to have Positive and Negative

faces on Indian Economy.


ANNEXURE


Inflation

Documents

Transcript of Inflation