Inflation and Deflation are the reasons for prise rise and fall of the materials in the market. Goverment tries to control the inflation rates by using differerent monetory policies. Syllabus of UPSC GS paper 3 has economics in it. And students should be clear with the concepts of economics. It is also very essential for the students to keep a track of current affairs related to economics. To read more articles on Economics click here.
- Inflation & Deflation
Inflation is generally understood as an economic process which denotes a substantial and rapid general increase in the level of prices and consequent deterioration in the value of money over a period of time. Thus, inflation is a sustained rise in price level over a period of time. It can be measured in terms of percentage increase in the price index as a rate per cent per unit of time, say a month or a year.
What is inflation?
- “Inflation is a state in which the value of money is falling or prices are rising.”
- “The obvious definition of inflation is that inflation is a rising price-level.” — Edward Shapiro
- “Inflation is a self-perpetuating and irreversible upward movement of prices caused by excess of demand over capacity of supply.” — Emile James
- “Inflation consists of a process of rising prices.” — A.C.L.Day
- “Inflation is a general and continuing increase in prices. This does not imply that all prices are increasing, some prices may even be falling, the general trend must be upward. The rise in prices must also be continuing; once and for all price increases are excluded.” — Michael R. Edgmond
Features of Inflation
Some of the characteristics of inflation are as follows:
- Inflation is associated with a sustained rise in prices. It is different from a temporary price
- Price rise is persistent and immediately
- Inflation is an economic phenomenon, e., the result of economic forces.
- Inflation is also a monetary Excess supply of money may cause inflation.
- The real value of money shows a falling trend. Inflation occurs under the following circumstances:
- The quantity of money is increasing but the volume of production is static or is even
- The quantity of money is stable but the volume of production is
- The quantity of money as well as the volume of production is increasing but the rate of increase in volume of production is lesser than the rate of increase in the quantity of
- The quantity of money is declining and the volume of production is also declining, but decline in production is higher than the decline in the quantity of
- The quantity of money, e., supply is in excess of demand or requirements.
As a post-full employment phenomenon
Some economists including Pigou and Keynes regard inflation as a phenomenon of full employment. According to Keynes, rising prices in all situations can’t be termed inflation. In a situation of underemployment, when an increase in money supply and rising prices are accompanied by an expansion of output and employment, inflation does not occur. But, sometimes, due to bottlenecks in the economy, an increase in money supply may cause costs and prices to rise more than the expansion of output and employment. This is known as semi-inflation or bottleneck-inflation. However, once a level of full employment is reached, the entire increase in money supply is reflected by rising prices. This, according to Keynesian view, is a case of true inflation.
Causes of inflation in India
- Increase in government expenditure
- Expansion of money supply
- Deficit financing
- Bank credit
- Black money
- Population growth
- Over-dependence on agriculture
- Natural calamites
- Dependence on imports
- Miscellaneous factors
Types of inflation
Demand-Pull Inflation: It occurs when excessive demand for commodities pulls up their prices. This is the conventional inflationary situation of ‘too much money chasing too few goods’.
Cost-Push Inflation: It occurs when wages and other costs rise and the producers are successful in passing on the higher costs to the consumers in the shape of higher prices. Hyperinflation: It refers to a situation of runaway inflation reaching even up to 100 per cent per annum. It also refers to rapid inflation in which prices increase so fast that money loses its importance as a medium of exchange.
Changes in price level are measured by the following:
- Wholesale Price Index (WPI)
- Consumer Price Index (CPI)
- Gross Domestic Product (GDP) Deflator
GDP deflator, which distinguishes between physical growth in output and price rise, gives an accurate picture of the overall price level. Theoretically, the growth in physical output in an economy has to be matched by a corresponding growth in monetary flows. Any mismatch between the two gets reflected in the growth-rate and price changes. Monetary policy aims at managing the balance between growth in real flows and growth in monetary flows.
WPI, CPI & GDP Deflator
The new series of Wholesale Price Index (WPI) with 2004- 05 as the base year has a weighted average of indices covering 676 commodities, which are traded in primary, manufacturing, and fuel and power sectors. WPI is thus a measure of inflation of an economy on a wider scale. Services do not figure in this, as there is usually no wholesale price for services. The weightage for primary articles is only 20.11 per cent, reflecting the structural changes in the economy.
Consumer Price Index (CPI) is the retail price average of a basket of goods and services directly consumed by the people. It is, therefore, a more accurate benchmark for measuring inflation than WPI. At present, CPI uses 2001 as the base year measure. It is computed separately by the Labour Bureau, Government of India for the following three groups: (i) CPI for Industrial workers, (ii) CPI for Rural labourers and (iii) CPI for Agricultural labourers.
The GDP Deflator is arrived at by dividing GDP at current prices by GDP at constant prices in terms of base-year prices. This indicates as to how much of the growth in GDP in a year is due to price rise and how much due to increase in output. GDP deflator is now available only annually with a gap of one year.
Base years: One of the problems in the history of price rise in post-independent India is that the government of India has been changing the base year every 10 years. WPI (1950-51=10) was given up in mid-60s and a new series with 1960- 61 as base was introduced. Subsequently, it was shifted to 1970-71 and later to 1981-82. This was revised to 1993-94 and finally to 2004-05. Such shifts in the base year are necessary to reflect the fast structural changes in India’s economy as shown in the relative importance of agriculture and industry and by changes in production and consumption pattern of certain commodities.
Measure to control Inflation
Inflation has to be controlled in the beginning itself, otherwise it will take the shape of hyper-inflation, which might ruin the economy. The methods used to control inflation are generally known as anti-inflationary measures. Their main attempt is to reduce the aggregate demand for goods and services on the assumption that inflation is due to demand pull. The following are the anti-inflationary measures:
- Monetary Policy: It is the policy of the central bank of the country to use methods such as bank rate, open market operations, the reserve ratio and selective controls in order to control the credit-creation operation of the commercial banks and thus restrict the amount of bank credit in the This is called tight money policy.
- Fiscal Policy: It is the policy of the government with regard to taxation, expenditure and public borrowing. The government will introduce new taxes and raise the rate of existing taxes with the purpose to reduce the purchasing power in the hands of the Also, the government expenditure should be reduced so that the demand for goods and services is further reduced. Lastly, public debt (i.e., the debt of the government) may be managed in such a way that the supply of money in the country is controlled.
- Control over Investment: Controlling investments is considered necessary because, due to the multiplier effect, the initial investment leads to large increase in income and expenditure and the demand for both the consumer and the capital goods goes up Therefore it is necessary that the resources of the community should be employed for investment which does not have the effect of increasing inflation.
- Price Control and Rationing: Price control implies the fixing of the upper limits beyond which prices of particular goods should not The purpose of rationing is to distribute the goods in short supply in an equitable manner among all the people. This is generally the most effective method during war when monetary and fiscal policies do not yield any significant result.
- Increased Production: Another important measure to combat inflation is to increase the supply of goods through either increased production or increased imports
- Compulsory Savings: Schemes of compulsory savings may be introduced by the government to take from each person certain portion of his earnings. Its main object is to check inflation and provide for future security.
Deflation denotes the economic phenomenon when prices are falling and fall in prices is accompanied by a decreasing level of employment, output and income. While inflation implies excess demand over the available supply, deflation implies deficiency of demand to lift what is supply. When the supply of goods is more than its demand, there is their fall in prices. Thus, deflation arises when the total expenditure of the community is less than the value of output at existing prices. As a result, the value of money goes up and the prices fall.
It should be noted that merely falling prices cannot be called deflation. When the inflationary trend in prices is reversed by the government measures without creating unemployment and fall in output, the phenomenon is known as disinflation. Deflation, on the other hand, is an under- employment phenomenon as it means falling prices accompanied by a decreasing level of employment, output and income.
Effects of Deflation
Deflation is considered undesirable for an economy because of the following reasons:
- Effects on Production: Deflation has got an adverse effect on the levels of production, employment, income and investment climate. Since prices fall rapidly without a corresponding fall in the cost of production during deflation, producers incur heavy losses and so have to curtail investment and employment. Some firms even have to go into liquidation because of huge Thus, there is a general fall in production, employment, investment and income. Business pessimism emerges and, gradually, a state of depression develops in the economy.
- Effects on Distribution: Deflation has an adverse effect on the distribution of wealth and income The share of profit earners in the total national income decreases and that of fixed wage group increases. Thus, deflation favours the consumer class as the value of money increases. Investors in fixed interest-bearing securities, renters and fixed income earners stand to gain. Creditors also tend to gain at the expense of debtors. The debtors do not have adequate means to repay their loans and thus may have to go into liquidation.
Control of Deflation
Deflation can be controlled by taking the following measures:
The monetary authorities should follow cheap-money policy to avoid depression. They should use bank rate policy and open market operations to raise the volume of credit by the It is felt that with the increase in the level of credit, there will be an increase in the levels of investment, production and employment.
- The government should attempt to reduce the level of taxation so as to leave a larger amount of purchasing power with the The government should also resort to deficit financing (i.e., expenditure in excess of revenues). It should increase its expenditure on public works programmes to increase the level of employment. There will, thus, be more income with the people who will spend money on consumer items leading to a stimulation to increase production by the businessmen.
- The government may resort to price support programme, under which the government may fix the prices below which the goods will not be sold and will also undertake to buy the surplus stocks from the
- The government may give subsidies to poor and unemployed people so that they survive the depressionary trend and continue to demand the essential items of Consumptions
INFLATION & DEFLATION
Generally, it is believed, that deflation is exact opposite of inflation. But this is not so because inflation is rise in prices unaccompanied by increase in employment and output while deflation is fall in prices accompanied by decreasing employment and output. The other points of difference between inflation and deflation are discussed below:
- Impact on Income: Inflation does not reduce the income of the community; it only distorts the distribution of income among various classes. Deflation, on the other hand, reduces national income through contraction of
- Impact on Society: Inflation is always demoralising for the society as it introduces the spirit of It is unjust as it promotes speculation and hoarding and diverts business skill and efficiency from productive purposes to speculative purposes. On the other hand, deflation is inexpedient since it increases the level of unemployment in the economy because of contraction of production. Thus, the whole society suffers in case of deflation.
- Erosion of Savings: Inflation erodes real savings of the people by reducing the value of money, but during depression there is lack of purchasing power because of fall in employment level and in investment
- Control: Inflation can be controlled by adoption of various monetary and fiscal measures in a co-ordinated manner, but it is very difficult to control Once the deflationary trend starts, it injects pessimism into businessmen, who stop further investment, which ultimately leads to depression. It is very difficult for the monetary authority to control deflation.
The above discussion clearly shows that inflation is unjust and deflation is inexpedient. Keynes showed a preference for inflation because it is the lesser of the two evils. Inflation is a post-full employment phenomenon whereas deflation is an under-employment phenomenon which aggravates the problem of unemployment which no country wants to face.
In case of developing economies, a mild inflation can stimulate economic development leading to increase in employment and production. Nonetheless, the dangers of inflation should always be kept in mind because once it goes out of control, it will give rise to hyperinflation which no economy can withstand.
It is not at all necessary that inflation is accompanied by a growth in employment. In the recent years, many countries of the world have been experiencing a situation in which price levels have been r ising continuously, and simultaneously there has been a rise in the rate of unemployment and stagnation in the rate of growth. Such a situation has been termed stagflation by Samuelson. “Stagflation involves inflationary rise in prices and wages at the same time so that people are unable to find jobs, and firms are unable to find customers for what their plants can produce.” Thus, when inflation is accompanied by recession in an economy, stagflation is said to exist.
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