CONCEPT OF INFLATION & STAGFLATION

Inflation Inflation refers to general rise in prices According to Prof. Crowther “inflation is a

state in which the value of money is falling i.e. Prices are rising”

There are various types of Inflation

Types of Inflation Basis of Rate Inflation

Creeping Inflation Walking Inflation Running Inflation Galloping Inflation Hyper Inflation

Basis of Govt Intervention Basis of Coverage Time Period

Basis of Causes Credit Scarcity Deficit Currency Profit Tax Wage Foreign trade Stagflation

Types of Inflation – Basis of Rate Inflation

Creeping Inflation – 3% p.a. , mild inflation, tolerable

Walking Inflation – 3-6% p.a. – should be taken care of not converting into running inflation

Running Inflation – 10-20% p.a. Galloping Inflation – More than 20% - serious

problem – will harm all sectors of economy

Types of Inflation – Basis of Rate Inflation

Hyper Inflation price rise will be at every moment – change in price will be

difficult to measure In terms of %, it would be more than 1000% per year Austria, Hungary, Poland, Germany & former USSR experienced

hyper inflation during World War I Germany experienced severe hyper inflation in 1924 Prof Samuelson, described hyper inflation in a statement, “we

used to go to store with money in our pockets & come home with food in our baskets, now we go with money in our baskets & return with foods in our pocket

Hyper inflation is a serious problem

Types of Inflation Basis of Govt Intervention – Open, Repressed Inflation Basis of Coverage – Sporadic (in 1 particular sector

only) Comprehensive (Covers entire economy) Time Period – Peacetime, War Time, Post war time Basis of causes

Credit Inflation – banks create credit – more money supply – more demand for goods & services – if supply of goods & services is less than demand then price rises

Basis of Causes Scarcity Inflation – scarcity of goods & services due to

fall in production or artificial hoarding Deficit Inflation – when BOP is in deficit – central bank

resorts to deficit financing i.e. creation of new money by launching new projects – leading to more supply of money – more demand of goods – hence rise in price

Currency Inflation – supply of money is more than supply of goods & services hence price rise

Basis of Causes Profit Inflation – Excess profits earned by

entrepreneurs – inflation causes them to earn more profits – thereby investing more – more supply of money – more demand of goods – hence rise in price

Wage / Cost Inflation – price rise due to rise in cost of production – costs includes wages, rent, interest etc. – wage is most imp factor

Basis of Causes Foreign Trade induced Inflation – export induced -

international demand increases but the supply is not able to match demand – price rises Import induced – rise in price of imported components –

rise in price of final product Stagflation – emerged post WW 2, situation where high

rise in price with high rate of unemployment – co-existence of stagnation & inflation called as Jobless Growth

Stagflation In India In India, stagflation refers to a situation of slow growth rate

or recession along with high rate of inflation India experienced stagflation from 1991-1994 Factors

responsible for stagflation were Decline in public sector investment, restrictions on imports,

high rate of interest, increase in money supply, rise in price of oil & other prods like coal, steel, cement etc.

Above factors resulted in slow growth rate & high inflation

Stagflation In India Govt tried curb inflation by reducing money

supply in mkt, reducing fiscal deficit to control demand & boost supply

Due to govt efforts, growth rate improved lowering the rate of inflation & unemployment

Since 2014, oil prices have reduced leading to fall in rate of inflation

Demand Pull Inflation Developed by J.M. Keynes It arises due to aggregate demand of goods & services is

more than its supply Demand may be more, due to increase in money supply It is associated with full level of employment i.e. all the

resources of nations are completely employed In such scenario, demand increases as money supply

has increased in market However, Supply cannot be increased as resources are

fully utilized

Cost Push Inflation Refers to rise in price level due to rise in cost of production It may occur due to rise in wage rate or due to rise in rate of

profit. Wage is a major component in cost Employers try to pass on this additional cost to the customers

by increasing price thereby increasing cost of living Workers will further ask for revision in wage as cost of living is

increasing Inflation may also occur when profit margin is increased i.e.

Profits being determined on the basis of mark-up over cost o production – known as mark up inflation

Causes of Inflation

Expansion of Money Supply

Increase in Disposable Inc External Demand (Export)

Rise in Expenditure Future Expectations

Inadequate Resources Hoarding & black

Marketing Natural Calamities Exports Full Employment

Situation

Factors influencing Demand Side

Factors influencing Supply Side

Effects of Inflation on Production Adverse effect on Capital Formation – Reduction in savings as

cost of living rises – less savings will lead to less investment & poor capital formation

Production distortion – inflation distorts production by diverting resources to the production of non-essential goods (higher profit margin) from essential goods (lower profit margin)

Hoarding & black Marketing Speculation Profit Orientation & Quality Deterioration Erosion in the value of money

Effect of Inflation on Distribution of Income &

Wealth Cost of production of goods tend to increase during inflation, however,

price rises more than rise in cost of production thereby increasing profit

During inflation, businessmen, traders, speculators gain maximum Worst affected section is the fixed income group When worker class tries to get increment on their current salary, it

results in cost push inflation Debtors & Creditors are affected differently – Debtors benefit as when

they are repaying the loan the value of money has fallen and creditors lose as the money received by them is not the same in terms of real money

Effect of Inflation on Distribution of Income &

Wealth People who invest in shares or bonds will gain more due to higher

profits earned by firms On the other hand, people investing in assets reaping fixed income

(Fixed Deposit etc) will be in loss Farmers benefits from inflation as they would earn more on the

products produced. It will also increase the cost of production but rise in price is more than rise in cost.

However, the advantage is gained by rich farmers than poor farmers Thus, inflation redistributes income in favour of businessmen, debtors

& farmers at the expense of fixed income group, creditors & consumers

Social & Political Effects of Inflation

Inflation helps rich to become richer & makes poor more poorer

Inequality widens, leading to social injustice Inflation helps businessmen & traders to sell sub-

std products at higher rates, black marketing etc. People start losing confidence in govt if it does not

intervene to curb the inflation thus creating issues in social harmony & political stability

Measures to Control Inflation

Various measures are required to control inflation Inflation is caused due to disequilibrium in demand

& supply, hence measures are directed towards influencing them

Following are the measures adopted to curb inflation Monetary Measures Fiscal Measures Other Measures

Monetary Measures Inflation arises due to more money supply in market

hence central bank tries to control the money supply by controlling the credit created by commercial banks

Central bank uses 2 methods – quantitative & qualitative Quantitative Method – controlling the volume of credit in

market Qualitative Method – controlling the direction of credit by

consumer credit regulation, changing the margin requirements

Fiscal Measure Measures related to taxation, public expenditure &

public debt is known as fiscal measures. Govt uses these factors to curb inflation

Reduce demand by increasing taxes of goods & services, increasing direct tax on income

Reduction in public expenditure Public Debt – borrowing money from public will reduce

the money supply in market thereby reducing inflation

Other Measures Incentives are offered by govt to producers

of essential items Efforts are undertaken to increase the

supply of goods (so that excess demand can be managed)

Controlling the prices of essential items Import of essential items if acute shortage

(depends on position of BOP)

Deflation Refers to a situation where prices keep

declining along with fall in employment, output & income

Opposite of inflation Decline in prices could be due to govt

measures, however it would not be termed as deflation

Deflation only occurs when the fall in price is accompanied by decline in output, employment etc.

Questions 1. Explain inflation and its various types 2. Stagflation in India (including Demand Pull & Cost Push

Inflation)3. Causes of Inflation 4. Effect of Inflation (Any 2 can come for a long answer or

any 1 can come for Short Note) 5. Measures to Control Inflation (Any 1 can come for Short

Note) 6. Deflation – Short Note