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INFLATION

About 

Inflation is a general rise in prices. To be more concrete, inflation is a persistent rise in the general price level rather than a once-for-all rise in it. When there is a persistent rise in prices, people need more and more money to buy goods and services.

The poor suffer the most from the persistent price rise, especially for food grains and other essential items.

Types of Inflation 

• Creeping inflation
  
  
• It occurs when price increases are exceedingly sluggish, similar to those of a snail or creeper. In terms of rate, "creeping inflation" is defined as a prolonged rise in prices with an annual increase of less than 3% per year. A price increase of this magnitude is considered safe and necessary for economic progress.
  
  
• Walking or Trotting Inflation
  
  
• When prices rise gradually and the yearly inflation rate is in the single digits. In other words, the rate of price rise is in the middle range of 3 to 7% each year, or less than 10%. Inflation at this rate is a warning indication to the government that it has to manage it before it becomes running inflation.
  
  
• Running Inflation
  
  
• It occurs when prices grow at a pace of 10 to 20% per year, similar to the running of a horse. Such inflation has a negative impact on the poor and middle classes. Its containment necessitates strong monetary and fiscal policies, otherwise, it will lead to hyperinflation.
  
  
• Hyperinflation
  
  
• When prices rise at double or triple-digit rates of more than 20% to 100% per year or more, this is referred to as runaway or galloping inflation. 
• It occurs when inflation grows at an exceedingly rapid rate. The rate of inflation can rise by 50 to 300 times.
• The consequences of hyperinflation may be disastrous for the economy. The scenario may result in the entire collapse of the value of the economy's currency, as well as an economic crisis, mounting foreign debt, and a decline in the purchasing power of money.
• In reality, hyperinflation occurs when the pace of inflation becomes unmeasurable and uncontrollable. Every day, prices grow dramatically. Because of the constant decline in the purchasing power of money, such a situation leads to the eventual collapse of the monetary system.
• Causes
• The government prints too much money to cover its deficits, wars, and political instability.
• An unanticipated increase in people's expectations of future inflation
  
  
• Structural Inflation
  
  
• As the economy grows, rigidities emerge, resulting in structural inflation. In the beginning, there is a gain in nonagricultural income, which is accompanied by a high population growth rate, which tends to raise demand for commodities. In reality, the pressures of population growth and growing urban earnings would tend to boost, via a chain reaction process, first farm commodity prices, then the general price level, and last wages.
• Supply inelasticities can cause agricultural price increases, import substitution costs, deterioration of trade conditions, and currency depreciation.
• It is common in developing and low-income countries.
• The Structuralist contends that developing-country economies are structurally undeveloped and extremely volatile as a result of weak institutions and inadequate market functioning. As a result of these flaws, certain sectors of the economy, such as agriculture, will have supply shortages, while others, such as consumer products, will face excessive demand. Such economies experience both supply shortages and underutilization of resources, as well as excessive demand in some areas.

Terms related to inflation

Causes of Inflation

• Demand-pull inflation
  
  
• It is often known as excess demand Inflation is the most prevalent and conventional sort of inflation. It occurs when aggregate demand increases but the accessible supply of commodities decreases. Products may be in low supply because resources are limited/exhausted or production cannot be increased quickly enough to satisfy rising demand. As a result, prices start to rise in response to what is commonly referred to as "too much money chasing too few commodities."
• It can be caused by 
• The rise in the money supply
• Rise in foreign exchange reserves
• The rise in government spending
• Fall in the unemployment rate
• Currency depreciation
  
  
• Cost-Push inflation
  
  
• It occurs when the aggregate supply of goods and services decreases due to external factors that cause a rise in the price level. Along with the decrease in supply, the national income also decreased. This may happen if there is an initial increase in the costs independent of any increase in demand.
• It is also called supply-side inflation.
•  There are 4 autonomous reasons for the increase in the costs

• Oil price shock  

The sharp increase in oil prices caused inflation in all oil-importing countries.

• Farm price shock

Raw material price increases, particularly for agricultural goods, can also act as a cost-push for inflation. Food inflation (increased food costs) is triggered by supply-side causes.

• Import price shock

The countries' currencies are flexible and are determined by currency demand and supply. As a result of currency depreciation (requiring more currency to buy products from foreign), cost-push inflation will occur.

• Wage-push inflation

The fundamental source of cost-push inflation is an increase in money wages faster than labor productivity. Trade unions are pretty influential in advanced nations. They force businesses to approve salary increases far greater than advances in labor productivity, boosting the cost of commodity production. Employers, in turn, hike their product prices. Despite increasing costs, higher income allows employees to buy the same amount. On the other side, price increases encourage unions to seek even greater pay. As a result, the wage-cost spiral persists, resulting in cost-push or wage-push inflation.

• Cost-push inflation not only causes a rise in price level but also brings about a fall in GDP level.
  
  
• Monetary policy 
• It is responsible for determining the supply of currency in the market. Inflation is caused by an excess money supply. As a result, the currency's value falls.

• Fiscal Policy

• It monitors the economy's borrowing and expenditure. More borrowings (debt) result in higher taxes and more currency creation to service the loan.

• Exchange Rates

• Depreciation of the currency increases the cost of imports, putting additional strain on people's pockets in a country with an import-oriented economy.

• Inflationary expectations

• An important cause of inflation. The expectation of future prices plays a significant role in decision-making by the firms. It can lead to inertia, making it difficult to stop the inflationary spiral. If prices have been rising and if people’s expectations are adaptive that is they form their expectations.

Impact of high inflation

• Boost in the investment in the short-run which is due to 
• High inflation will raise the demand for goods and services which will further expand the production level of entrepreneurs.
• High inflation also means a lower cost of loans.
• In the short run, savings will increase and in the long run, they will decrease.
• Exchange rate– currency depreciation
• Trade balance
• Developed countries will have a favorable trade balance and developing countries will have an unfavorable trade balance due to the composition of foreign trade.
• In the short run, employment will increase. In the long run, it will decrease or will be neutral.
• Banking sector will have the pressure of higher lending 

Remedial measures to control inflation

• The RBI's monetary policy attempts to control the supply of money in order to fulfill the needs of various sectors of the economy and stimulate economic growth. This strategy is implemented by raising interest rates and lowering bond prices. This helps to lower the costs associated with inflation, which halts economic growth and raises the inflation rate.
• Fiscal Policy: The government can pursue fiscal policy in two ways:
• Reduce expenditures on schemes, initiatives, and so on.
• Raising direct or indirect taxes.
• Measurements of Supply Management:
• Import items in short supply and reduce exports
• Public Distribution System Distribution
• The government may investigate hoarding.
• All control strategies for demand-pull inflation focus on lowering demand, which may be accomplished by either reducing the money supply or increasing prices through taxes.

Indices to calculate the inflation

• Consumer price index (CPI)

1. It measures price changes in a basket of consumer goods and services purchased by households. 
2. It is a numerical estimate based on the prices of a sample of typical objects, the prices of which are collected on a regular basis.
3. It measures changes in the consumer price level.
4. The National Statistical Office publishes it, under the Ministry of Statistics and Programme Implementation (MoSPI).
5. The base year is 2012.
6. The CPI basket includes a diverse range of commodities, with 448 in the rural basket and 460 in the urban basket. 
7. It is a significant economic indicator that is commonly regarded as an inflation barometer, a tool for monitoring price stability, and a deflator in national accounts.
8. CPIs are classified into four types:
1. CPI for Industrial Workers (IW).
2. CPI for Agricultural Laborers (AL).
3. CPI for Rural Laborers (RL).
4. CPI (Urban/Rural/Combined).

• Wholesale Price Index (WPI)

1. The Wholesale Price Index represents the wholesale price of a basket of commodities.
2. WPI is compiled and released by the Office of the Economic Advisor in the Department of Industrial Policy and Promotion, Ministry of Trade and Industry.
3. It is focused on the pricing of items (goods) traded between firms.
1. It does not focus on things purchased by customers.
2. It tracks price fluctuations in items sold and traded in bulk by wholesale enterprises to other businesses.
4. WPI's primary goal is to monitor price fluctuations that reflect demand and supply in manufacturing, construction, and industry.
5. Components of WPI and their weightage–
1. Manufactured items (64.2%) 
2. Primary articles (22.6% )
3. Fuel and power (13.1%)
6. The base year is 2011-12
7. It consists of a total of 697 items.
8. Limitation– it does not include the unorganized sectors as well as services.

• Producer Price Index (PPI)

1. It is a price change index for the manufacturing process.
2. It measures the average change in the selling prices of manufacturers' goods and services.
3. It monitors variations in the prices of products and services sold to final and intermediate demand.
1. Demand met through consumption is referred to as final demand, whereas demand created by the production process is referred to as intermediate demand.
4. Its purpose is to address price rises at the producer level before they are passed on to consumers, and it excludes indirect taxes, transportation, trade margins, and so on.
5. The PPI is considered a neutral instrument for pricing adjustments in long-term purchasing contracts.
6. In India, the PPI is not measured or computed.

• Index of Industrial Production (IPP)

1. It is a metric that illustrates the growth rates of various industry groups in the economy over time.
2. It is calculated and published monthly by the Central Statistical Organization (CSO).
3. The base year for this is 2011-12.
4. It provides information about the total level of industrial activity in the economy which is useful in calculating GDP growth.
5. It includes 682 articles divided into three categories: 
1. manufacturing, 
2. mining, and 
3. electricity. 
6. The total weight of the three is 1000.
7. I.I.P data is also given in terms of product categories and weights:
1. 456 basic items
2. Nondurable consumer goods - 213
3. 156 intermediate products
4. Capital goods - 88
5. Non-durable consumer goods - 84
8. Key sectors account for 38% of its total weight [coal, fertilizer, power, crude oil, natural gas, steel, cement, and refinery products]. 
1. Electricity has the most significant weight and fertilizer has the lowest weight. I.I.P. is released once a month.
9. Most item data comes from the DIPP (Department of Industrial Policy and Promotion), Ministry of Commerce and Industry, followed by the Indian Bureau of Mines. The remaining products come from ministries, commodities boards, and government departments.

• Service and price index

1. The Commerce Ministry's Department of Industrial Policy and Promotion (DIPP) has formed an expert group led by C P Chandrashekhar.
2. The index will measure the price fluctuations of numerous insurance, banking, transportation, and communication services such as insurance, banking, transportation, and communication.
3. This will be similar to the Consumer Price Index (CPI) and Wholesale Price Index (WPI), which give a crucial glimpse into the developments in commodity prices at the consumer and wholesale levels.

• Housing Price Index

1. The all-India housing price index (HPI) is published quarterly by the Reserve Bank of India with the base year of 2010-11.
2. It is based on transaction-level data acquired from home registration agencies in the country's ten largest cities.
3. Ahmedabad, Bangalore, Chennai, Delhi, Jaipur, Kanpur, Kochi, Kolkata, Lucknow, and Mumbai are among the cities.

 Purchasing Manager’s Index (PMI)

• 1. It is a survey-based metric that asks respondents about changes in their assessment of important business indicators from the previous month.

  2. PMI values and components are vital in giving decision-makers, market analysts, and investors relevant insight into a company's economic activities.

  3. The PMI's objective is to inform firm decision-makers, analysts, and investors about present and prospective business conditions.

  4. IHS Markit compiles PMI for over 40 economies throughout the world.

     1. IHS Markit is a worldwide leader in information, analytics, and solutions for the world's important sectors and markets.

     2. It is headquartered in London.

  5. It is published at the start of each month.
     
     
  6. It is often considered the super-leading predictor of economic activities.
     
     
  7. It is calculated independently for the manufacturing and service sectors before being combined to create a composite index.
     
     
  8. There are two types of PMI
     • PMI for manufacturing
     • PMI for Services.
• A combined index is also created by combining the manufacturing and service PMIs.
  
  Calculation
  
  
  1. 1. The range of the scale is between 0 and 100.
        1. A score of more than 50 indicates expansion, whereas a score of less than 50 indicates contraction.
        2. A score of 50 implies that there has been no change.
     2. In case of higher PMI of the previous month than the current month indicate that the economy is shrinking.