INFLATION

Topics to be discussed

Introduction & meaning of inflation

Theories of inflation

Causes of Inflation

Measures of Inflation

Effects of inflation

Inflation: Basic Definition

Inflation is a term used in economics to describe increases in prices. In simpler terms inflation is a decline in the purchasing power of money for goods and services.

Inflation: Advanced Definition

Inflation (as accepted by many

economists) technically speaking

should be defined as the increases

and decreases of the money

supply (i.e. currency)

Theories of Inflation

Demand Pull

Inflation

DEMAND PULL INFLATION OCCURS WHEN TOTAL DEMAND FOR

GOOD AND SERVICES EXCEEDS TOTAL SUPPLY. THIS TYPE OF

INFLATION HAPPENS WHEN THERE HAS BEEN EXCESSIVE GROWTH IN

AGGREGATE DEMAND AND THERE IS AN INFLATIONARY GAP.

DEMAND PULL INFLATION IN OFTEN MONETARY IN ORIGIN BECAUSE

THE AUTHORITIES ALLOW THE MONEY SUPPLY TO GROW FASTER THAN

ABILITY OF ECONOMY TO SUPPLY GOODS AND SERVICES.

THE PHRASE THAT IS OFTEN USED IS THAT THERE IS TOO MUCH

MONEY CHASING TOO FEW GOODS.

DEMAND PULL INFLATION CAN B ILLUSTRATED GRAPHICALLY BY

USING AGGREGATE DEMAND AND AGGREGATE SUPPLY

Graphical Representation of

Demand Pull Inflation

STRUCTRULIST THEORY

OF INFLATION

Structuralist theory of inflation explains inflation in the developing countries. Structural theory of inflation has been put forward as an explanation of inflation in the developing countries especially of latin america. Myrdal and streeten, well known economists have argued that it is not correct to apply highly aggregative demand supply model for explaining inflation in the developing countries. According to them, there is a lack of balanced integrated structure in them where substitution possibilities between consumption and production and inter sectoral flows of resources between different sectors of the economy are not quite smooth and quick smooth so that the inflation in them can not be reasonably explained in terms of aggregate demand and aggregate supply.

To explain the origin and propagation of inflation in the

developing countries , the forces which generate these

bottlenecks or imbalances of various types in the process

of economic development need to be analyzed.

These bottlenecks are of three types.

Agricultural bottlenecks

Resources gap or governments budget constraint

Foreign exchange bottleneck

Agricultural Bottlenecks:-

The first bottleneck faced by the developing countries relate to agriculture and they prevent supply of food grains to increase adequately of special mention of the structural factors are disparities in land ownership, defective land tenure system which act as a disincentives for raising agricultural production in response to increasing demand for them arising from increase in peoples incomes , growth in population and urbanization.

Resources Gap or Governments Budget Constraint:-

This bottleneck relate to lack of resources for financing economic development. In the developing countries planned efforts are being made by the government to industrialize their economies. This requires large resources to finance public sector investment in various industries.

Foreign Exchange Bottleneck :-

The other bottleneck which the developing countries have to

encounter is the shortage of foreign exchange for financing

needed Imports for development. In the developing countries

ambitious programme of industrialization is being undertaken.

Industrialization requires heavy imports of capital goods,

essential raw materials and in some cases, as in India, even food

grains have been imported.

MEASURES OF

INFLATION

FISCAL MEASURES

Fiscal policy is based on the theory of British economist John Keynes (1883-1946) also known as Keynesian Economics. This theory states that Government could change economic performance by adjusting tax rates and government spending. This influence in turn, curbs inflation increase employment and maintains a healthy value of money. Fiscal policy is important to the economy.TO illustrate how Govt. could try to use fiscal policy to affect the economy, consider an economy that’s experiencing a recession. The Govt. might lower tax rates to try to fuel economic growth..

If people are paying less in taxes, they have more

money to spend or invest. Another possibility is that the

Govt. might decide to increase its own spending –say by

building more highways. The idea is that the additional

Govt. spending creates job and lowers the

unemployment rate. Thus, in period of inflation the Govt.

should curb its own spending and increase tax rates to

reduce private spending. It is a good thing to plan for a

budget surplus during inflationary period

Monetary Policy

Monetary Policy

The best remedy for fighting inflation is to

reduce aggregate spending. Monetary

policy can help in reducing the pressure of

demand

Mechanics of Monetary policy are

Rising bank Rate

Directly controlling credit creation

Rising bank Rate:

Rise in the bank rate will be followed by rise in other market rates of interest. Rise in the rate of interest will reduce the amount of aggregate spending. For the following reasons.

1- borrowing becomes more costly then before the potential borrowers will postpone their investment plan. They would wait till interest rate forms to their normal level

2- It reduces consumer spending.

3- it also effects on business. It is a red signal to the

businessmen that bad times are ahead

CAUSES OF

INFLATION

INCREASE IN PUBLIC

EXPENDITUREPUBLIC EXPENDITURE HAS RISEN FORM 18.6% OF GDP IN

1961 TO AROUND 29% IN 2009_10.WITH A RISE IN NATIONAL

INCOME AND ALSO RAPID GROWTH OF POPULATION AN

INCREASE IN PUBLIC EXPENDITURE IS UNAVOIDABLE BUT

THIS RISE IS NOT JUSTIFIABLE APPROX. 45% OF GOVT.

EXPENDITURE IN INDIA IS ON NON DEVELOPMENT

ACTIVITIES, BY PUTTING PURCHASING POWER INTO THE

HANDS OF ITS EMPLOYEES, CREATES DEMAND FOR GOODS

N SERVICES BUT IT DOES NOTHING WHERE BY THEIR SUPPLY

COULD INCREASE. UNDER THESE CIRCUMSTANCES D

GENERAL PRICE LEVEL SHOWS N INEVITABLE TENDENCY TO

RISE.

ERATIC AGRICULTURAL

GROWTH

THE INDIAN AGRICULTURE LARGELY DEPENDS ON

MONSOONS AND THUS CROP FAILURES DUE TO DROUGHT

HAVE BEEN REGULAR FEATURE OF AGRICULTURE IN

COUNTRY.IN D YEARS OF SCARCITY OF FOOD GRAINS NOT

ONLY PRICE OF FOOD ARTICLES INCREASES BUT THE

GENERAL PRICE LEVEL ALSO RISES.

AGRICULTURAL PRICE POLICY OF

GOVERNMENT

THE GOVT. HAS BEEN PURSUING A POLICY OF PRICE TO

SUPPORT THE AGRICULTURISTS. FOR THIS IT ANNOUNCES THE

PRICE AT WHICH IT WOULD BE BUYING AGRICULTURAL

PRODUCTS. IS ENSURES CERTAIN MINIMUM PRICE TO THE

FARMERS. THIS POLICY BENEFITED FARMERS IN INDIA BUT DIS

HAS BEEN A MAJOR CONTRIBUTORY FACTOR TO

INFLATIONARY PRICE RISE IN COUNTRY.

UPWARD REVISION OF

ADMINISTERED PRICES

THERE ARE A NUMBER OF IMPORTANT COMMODITIES FOR

WHICH PRICE LEVEL IS ADMINISTERED BY THE GOVERNMENT.

MANY OF THESE COMMODITIES ARE PRODUCED IN THE

PUBLIC SECTOR. THE GOVERNMENT KEEPS ON RAISING

PRICES FROM TIME TO TIME IN ORDER TO COVER THE LOSSES

IN THE PUBLIC SECTOR WHICH OFTEN ARISE DUE TO

INEFFICIENCY AND UNIMAGINATIVE PLANNING. THIS

POLICY RESULTS IN COST PUSH INFLATION

OTHER FACTORS

FAILURE OF GOVT. TO FULLY BRING WITHIN THE AMBIT OF

TAXATION D INCREASING INCOME OF D PEOPLE LARGE

SCALE TAX EVASION N AVOIDANCE, BLACK MARKING AND

HOARDING OF ESSENTIAL COMMODITIES,

INFRASTRUCTURAL BOTTLENECK AND RISING PRICES OF

IMPORTS.

Thank YouMADE BY AHSAN AHMAD BABA