Posted in Finance Articles, Total Reads: 3284
, Published on 24 February 2013
Economists often use the term “Inflation” to indicate growth and stability of a nation or market . If we go by the definition given in investopedia.com it is : “The rate at which the general level of prices for goods and services is rising, and, subsequently, purchasing power is falling.”
Logically inflation is large amount of money seeking small amounts of goods . there are few causes behind this unusual behaviour–
Over supply of money in the economy – It is truly said that too much of anything is bad . it works the same for money too if there is more money in the economy , public will have more to spend , more to spend will lead to more demand , and this increased demand will lead to reduction in quantity supplied and eventually to inflation.
High population -- A large population will require more goods to satisfy themselves , this will cause more demand and scarcity of resources . Ultimately the producers have to increase the per unit price of good and this aggravates inflation .
Increase in labour cost – Increase in the input cost of the labour will cause increase in the overall product cost . The manufacturers will have no other option but to overprice the goods so that they may get the desired margins.
Rising prices of imported goods – sometimes a country has to pay more ,while importing a good due to foreign exchange fluctuations . These fluctuations will add up to to increased price of the goods and later to inflation. One of the examples is the price at which oil and gas has been imported by India. The prices have dramatically increased to $93.47 per barrel from $36.54 in year 2000. In just a decade this 150% increment in crude oil prices have shown that the resources are scarce and more price appreciation will happen in future.
A reduction in tax rates – Tax policies have kept the public under control from spending . With the revision of subsidised taxes public will have more money at their disposal ,this disposable income will cause the demand to rise and real GDP to increase resulting into inflation .
Inflation has also imparted some side effects like :
Reduction in GDP – Due to increased price, public will buy less of the goods , due to which the production will experience a slowdown , and eventually the GDP will go down.
Banks will charge higher interest rates due to higher rates of inflation , this will make borrowing more costly thus people will buy less of goods like Cars, houses etc. Apart from these , trade union issues , import-export imbalance and uneven income distribution are other side effects of inflation.
Solution – It has been observed that the solution implemented by government to tackle this problem takes a lot of years . some of the usual measures which can be /are taken by government are –
Monetary policy – RBI has raised the REPO rate by 350 basis point at the end of year 2011 to fight inflation, also the CRR has been revised and this has caused less money to get circulated in economy.
Certain governments have implemented fixed exchange rates to fight inflation. under this fixed exchange rates the value of the currency remains stable over a given period of year , and this helps in avoiding currency devaluation .
Import/export restrictions – many times governments reduce the import of certain high priced goods , sometimes it also refrains from exporting staples food items like pulses cereals, rice ,edible oil etc. so that more goods remain available for the general public and the supply does not face any restriction.
Government also implemented pricing policies for the poor’s like maintaining the Central Issue Price (CIP) for rice (at Rs 5.65 per kg for BPL and Rs 3 per kg for AAY) and wheat (at Rs 4.15 per kg for BPL and Rs 2 per kg for AAY) since 2002.
Encouraged foreign and public investments to maintain a demand –supply balance .
The rise in mortgage interest rates will reduce homeowners' real 'effective' disposable income and they will have less money to spend on other goods.
If government can implement supply reforms where a greater good can be produced at lesser cost and sold at a reduced price.
Hence it can be concluded that inflation is a multi dimension issue which is required to be tackled at multiple fronts and cannot be addressed by one single solution, only a combination of policies and measures could be the best bet for Indian economy.