What is INFLATION? Inflation is nothing but a general increase in the prices of various goods and services over time in an economy. When general values increase, the purchasing power of each unit of money decreases, that is, the quantity of goods or services that came before a given quantity of money decreases.
The situation of high rate of inflation is very harmful for the public and works to spread poverty. Economists believe that these bad conditions arise from the excess of money supply, that is, it takes birth by printing more money than the economy needs. The opposite of inflation is deflation, that is, the condition in which the prices of goods and services fall over time.
Measurement of Inflation in India
1. Wholesale Price Index – WPI
It is the most used inflation indicator in India.
the Office of the Economic Adviser, Ministry of Commerce and Industry are the publisher of it.
It includes all the transactions done at the first point of abundance sale in the domestic market.
The most prominent criticism of this index is that the general public does not buy the product at wholesale price.
2004-05 to 2011-12 are the base year of All India WPI.
2. Consumer Price Index – CPI
It measures the price change from the point of view of the retail buyer.
It measures the change over time in the level of retail prices of selected goods and services at which a defined group of consumers spend their income.
Following are the four types of CPI
1. CPI for Industrial Workers – IW
2. CPI for Agricultural Laborer – AL
3. CPI for Rural Laborer – RL
4. CPI (Rural/Urban/Combined)
The Labor Bureau in the Ministry of Labor and Employment is the first three of these. Whereas the Central Statistical Organization (CSO) under the Ministry of Statistics and Program Implementation is the fourth type.
The base year of CPI is 2012.
Consumer Price Index vs Wholesale Price Index
The wholesale Price Index (WPI) is used to find out the prices of commodities at the wholesale level. It is virtually impossible to measure or detect the change in prices of all the commodities in the economy. Therefore, inflation is measured by taking a sample in the Wholesale Price Index. Thereafter, a base year is fixed in relation to which the current inflation is measured.
In India, inflation is calculated by the Wholesale Price Index (WPI)
Inflation in the Consumer Price Index (CPI) is measured at the retail level to which consumers are directly involved. This method better measures the effect of inflation on the general consumer.
Inflation based on WPI is measured at the producer level, while CPI measures changes in prices at the consumer level.
While both baskets measure inflationary trends (the speed of price signals) within the broader economy, the two indices differ in which weights are determined for food, fuel and manufactured goods.
WPI excludes changes in the prices of services, whereas CPI covers the prices of services.
In April 2014, RBI adopted CPI as the key measure of inflation.
There can be many reasons for inflation. These reasons can be divided into two parts:
Demand factors arise from an increase in the demand for goods and services, whereas a price increase factor apparently arises from an increase in the price or a decrease in the supply of a goods service.
Increasing government expenditure – which has been increasing for the last several years, due to which more money comes into the hands of the general public which increases their purchasing power. It is a mainly unplanned expenditure that is unproductive in nature and only increases the purchasing power and demand.
The increasing government expenditure, due to deficit and increase in money supply, is met by deficit budget and by printing new currency which increases both inflation and supply.
PRICE ESCALATION FACTOR
- Fluctuations in production supply: Whenever there is a lot of fluctuation in production or profit-making people deposit the output obtained.
- Wage increases in excess of productivity, increase the cost price, which in turn increases the price, as well as increases in demand and purchasing power, which increase under the former head.
- Indirect taxes also tend to increase the cost of materials by raising the cost price.
- Deficiency or defect in infrastructure development increases the cost per unit which increases the general price.
- Increase in administered price such as the minimum support price for food grains or the price of petrol and other products which the government voluntarily decides as they form a major part of the budget of the common man.
EFFECTS OF INFLATION
Inflation has the following effects on the economic sector and non-economic sector of an economy:
1. Impact on Investor
There are two types of investors. The first type of investors is those who invest in government securities. Fixed income is obtained from government securities and other investors are those who buy shares of joint-stock companies. Their income increases with inflation. Inflation will hurt the first class of investors and benefit the second class.
2. Impact on the class of fixed income
In the category of fixed income, all those people whose income is fixed such as workers, teachers, bank employees etc. Due to inflation, the prices of goods and services increase, which affects the fixed income group. Thus the fixed income group suffers losses due to inflation.
3. Impact on Farmers
Inflation has a favorable effect on the farming class because the farming class produces and during inflation the prices of production rise. In this way the farming class gets the benefit during inflation.
4. Impact on Borrower and Lender
Inflation has an adverse effect on the lender and a favorable effect on the borrower. Because when the lender lends his rupee to someone, the value of his rupee will decrease due to inflation. Thus the lender suffers from inflation and the borrower gains.
5. Impact on Savings
Inflation has an adverse effect on savings because due to inflation there is an increase in expenditure on goods. This will reduce the chances of saving. On the other hand, inflation will reduce the value of money and people will not want to save.
6. Impact on Balance of Payments
While there is inflation, the prices of goods and services increase. Due to this, our exports will become expensive and imports will become cheap. There will be a decrease in exports and an increase in imports due to which the balance of payments will become unfavorable.
7. Impact on Public Debt
Public debt increases due to inflation because when the price level rises, the government has to increase its expenditure on public schemes, the government takes loans from the public to meet this expenditure. Therefore, inflation leads to increase in public debt.
8. Impact on Taxes
The public expenditure of the government increases greatly due to inflation. To meet its expenditure, the government imposes new taxes and increases the old taxes. Thus inflation increases the burden of taxes.
9. Moral Impact
Due to inflation, the merchant class becomes blind in greed and uses hoarding, profiteering and adulteration etc. to sell the produce. Government servants indulge in corruption and moral values fall in individuals.
10. Impact on Producers
Due to inflation, the producers and entrepreneurs get benefits because the prices of the goods produced by the producers are increasing and the increase in wages is also less than the prices. Thus, it benefits the entrepreneurs and producers.
MEASURES TO CONTROL INFLATION
Following measures can be adopted to control inflation:
A. Monetary measures
Through monetary policy Central Bank, The Reserve Bank of India, can control inflation by regulating the supply of money. The following monetary measures can be used to control inflation.
1. Control the amount of money
It can be controlled by controlling the amount of money and the amount of money can be controlled by the central bank. In this way, when the central bank imposes tight control on the amount of money, the amount of money will be controlled.
2. Credit Control
The central bank can control credit to control rising prices. To control credit, the central bank can use both quantitative and qualitative measures. Under these measures, the bank can increase the rate, increase the repo rate and reverse repo rate, increase the minimum cash reserve, sell securities in the open market, rationing of credit, and increase the marginal requirement.
If it is not possible to control inflation, the government can also resort to demonetization. Under demonetization, the government replaces the old currency with a new currency. By which inflation can be brought under control
B. Fiscal Measure
Fiscal measures are taken by the Government. We can include the following measures in fiscal measures:
1. Reduction in public expenditure
An increase in public expenditure leads to an increase in the purchasing power of the people. An increase in purchasing power will lead to an increase in demand and an increase in demand will lead to an increase in the price level. In this way, by reducing public expenditure, we can control inflation.
2. Increase in Public Debt
The rise in prices is due to an increase in demand, which leads to an increase in public debt. To reduce the demand, the government can take loans from private individuals. When loans are taken from the private sector, there will be a reduction in the expenditure of the private sector. In this way, Inflation can also be controlled by increasing public expenditure.
3. Increase in Taxes
Public expenditure increases due to inflation. To meet this expenditure, the government imposes new taxes and increases the rates of old taxes. An increase in the rates of taxes has the opposite effect on production.
4. Reduction in deficit financing
A deficit financing system is adopted when the income of the government is less than the expenditure incurred by it, in deficit financing system the government issues new money and increases the money supply in the economy. Therefore, deficit financing has to be reduced to control inflation.
Apart from monetary and fiscal measures, there are some other measures to control it.
1. Increase in Production
Inflation can also be controlled by increasing output as inflation occurs when aggregate demand exceeds aggregate supply. Thus we can control inflation by increasing aggregate supply or output.
2. By encouraging savings
Inflation can also be controlled by increasing savings. The government should run schemes that encourage savings. When there is an increase in saving, there will be a decrease in private expenditure and demand itself will decrease and the price level will come under control.
3. Price Control and Ration System
Ration system is an important mechanism to control it. In the rationing system, the price level also does not increase much and everyone gets the goods as per their requirement.