INFLATION- CONCEPTS AND MEASURES TO CONTROL

INFLATION is the rate at which prices of goods and services increase. It is an indication of the rise in the general level of prices over time. Inflation (or rise in prices of goods and services) can be due to mainly two reasons i.e more demand or less supply.

Demand Pull Inflation: When the economy is having excess money, there is more demand for goods and services leading to rise in their prices, called Demand Pull Inflation.

Cost Push Inflation:- is due to rise in prices of raw material or cost of production resulting in enhanced price of final goods and services. This type of inflation is called Cost Push Inflation.

CALCULATING INFLATION:-

Due to innumerable goods and services produced in a country it is practically impossible to find out the average change in prices of all these goods and services traded in an economy. Therefore, a sample set or a basket of goods and services is used to get an indicative figure of the change in prices, which we call the inflation rate.

 

Inflation is calculated as the percentage rate of change of a certain price index. The price indices widely used for this are Consumer Price Index (adopted by countries such as USA, UK, Japan and China) and Wholesale Price Index (adopted by countries such as India). Inflation rate, generally, is derived from CPI or WPI. Both methods have advantages and disadvantages.

 

In India we use WPI method for inflation calculation.

If we have the WPI values of two different times , say, beginning of the year and end of the year, the inflation rate for the year will be,

(WPI of end of year – WPI of beginning of year)/WPI of beginning of year x 100

For example, WPI on Jan 1st 2012 is 105 and WPI of Jan 1st 2013 is 110 then inflation rate for the year 2013 is,

(110 – 105)/105x 100 = 4.76%

So inflation rate for the year 2013 is 4.76%.

CONTROLLING INFLATION:- Inflation is the rise in price levels in an economy over a given time period. This means that a given amount of currency will buy a lower number of goods as time passes as it loses its value. So controlling inflation is one of the main economic objectives of a government. Inflation is mainly controlled by measures aimed at either increasing aggregate supply or decreasing aggregate demand.

  1. MONETARY MEASURES:- A government’s monetary policy can decrease aggregate demand by increasing interest rates. This will discourage borrowing and increase savings, both of which constrict consumption, thereby decreasing aggregate demand. These measures are usually taken through Central Bank of the Country and are called Monetary measures. In India, Reserve Bank of India takes measures like hiking CRR, Bank Rate, Repo Rate, Reverse Repo Rate etc. i.e. Liquidity Adjustment Facility
  2. FISCAL POLICIES:- The government can increase taxation and decrease government spending. This will result in consumers and firms having less to spend, therefore coupled with the lower government spending this will cause leakages to increase and injections to decrease, reducing aggregate demand. Subsidizing the costs of firms will decrease production cost allowing them to lower their prices, also reducing inflation. Other ways to decrease inflation is to reduce tariffs on imports, as this will lead to lower prices and therefore lower cost-push inflation. Inflation targeting can lower the chances of both types of inflation by decreasing the expectations of inflation. In conclusion short term measures to control inflation seek to decrease aggregate demand, whereas long term solutions tend to increase aggregate supply. The Indian government usually takes fiscal measures like reduction in import duties, permitting import of good not previously permitted etc.
  3. ADMINISTRATIVE MEASURES are taken by government like banning export of particular goods, suspension of future trading in commodities. The stock limits for commodities can be prescribed by the government