Inflation  One day grandpa hands me a 5 rupee note and tells me to go and watch movie.  But I tell that 5 rupees will not even buy a packet of popcorn.  Grandpa tells that in his days 5 rupees could buy a movie ticket, popcorn and lots of other food.  I told him that this sounds interesting but why do these things doesn’t happen now?  Grandpa tells that it is because of inflation

Definition of Inflation  Inflation is a sustained increase in the general price level of the goods and services in an economy over a period of time.  Reduction in the purchasing power per unit of money.

Thus What is inflation?  Thus Inflation is defined as a sustained increase in the price level or a sustained fall in the value of money.  E.g.: Many years ago rice could be bought at Re.1 per kg but at present rice can be bought at Rs. 30 per kg. In simple terms this is inflation. Also, earlier rice was available at Re. 1 per kg but at present Re. 1 can buy one toffee. This means there is a fall in purchasing power of individuals. 4 4

Types of Inflation  I asked Grandpa what causes inflation.  Grandpa tells me its mango jam  I was surprised!!! Mango Jam? How does it cause inflation?  Grandpa tells that he used mango jam as an example.

Types of inflation  If the demand for mango jam increases while its production remains the same, there will be less mango jam available in the market and the price will go up. This is called demand pull inflation  Thus in Demand Pull Inflation the price rise occurs from an excess of demand over supply for the economy as a whole.

What are different types of inflation  Now if the demand for mango jam remains the same but its production is getting affected perhaps due to a bad year for mango cultivation or maybe there is a shortage of skilled workers to produce mango jam, it would cost more to produce mango jam, so its price would also rise. This is called cost push inflation.

Types of inflation  Cost Push Inflation: This type of inflation occurs when general price levels rise owing to rising input costs.  The three factors which contribute to this type of inflation are 1. rising wages, 2. increases in corporate taxes, and 3. imported inflation. [imported raw or partly- finished goods may become expensive due to rise in international costs or as a result of depreciation of local currency ]

Controlling Inflation  The Monetary Policy of the RBI has certain tools to control inflation.  Cash Reserve Ratio  Repo Rate  Reverse Repo Rate  SLR (Statutory Liquidity Ratio)  Bank Rate

Controlling Inflation  Cash Reserve Ratio (CRR): It is the percentage of total deposits of a commercial bank which it is required to keep in the form of cash reserve with the Central Bank.  Example: If an individual deposits Rs. 100/- in a bank, then the bank cannot use the entire Rs. 100/- for lending or investment purpose.  The bank has to maintain a portion of the deposit as cash and it can use only the remaining amount for lending or investment.  So if the CRR is 5% then it means for every Rs. 100/- deposited in a bank, the bank has to maintain a minimum of Rs. 5/- as cash.

Controlling Inflation  Repo Rate  It is the repurchase rate.  It is the rate at which banks borrow money from the central bank for short period of time by selling its securities/assets to the central bank  An agreement is done with between the central bank and banks that the bank will repurchase the securities from the Central Bank at a predetermined price at a future date.

Controlling Inflation  Reverse Repo Rate  It is the rate of interest at which the central bank borrows funds from commercial banks for a short time period.  The banks earn interest from their deposits in the Central bank.  The Central Bank uses Reverse Repo Rate to absorb liquidity from the economy.

Controlling Inflation  Statutory Liqiuid Ratio  Banks are required to keep a minimum percentage of deposits with them at the end of the day in the form of cash or gold or bonds or other securities apart from keeping a portion of their deposits with the Central Bank (CRR). This percentage is called Statutory Liquid Ratio.  E.g.: If an individual deposits Rs. 100 in a bank and if CRR is 6% and SLR is 7%, then the bank can use Rs =Rs. 87 for lending or investment purposes.

Controlling Inflation  Bank Rate  Bank rate is the rate at which banks borrow money from the central bank without any sale of securities.  It is generally for a longer period of time.  This is similar to borrowing money from someone and paying interest on that amount.

Current Scenario  Consumer prices in India was 5.77 percent year-on-year in June Last year it was 5.4 percent.  RBI has kept policy rates unchanged in the latest monetary policy since rise in food prices have triggered inflation.

Deflation  In economics, deflation is a sustained decrease in the general price level of goods and services.  Deflation occurs when the annual inflation rate falls below zero percent, resulting in an increase in the real value of money — a negative inflation rate.  Deflation increases the real value of money.  It increases the real value of money of a nation, this allows one to buy more goods with same amount of money.

Deflation  Deflation is caused by a fall in the aggregate level of demand.  This means that there is a fall in the price for goods.  Because the price of goods is falling, consumers have an incentive to delay purchases and consumption until prices fall further, which in turn reduces economic activity even further.

Controlling Deflation  Governments and central banks need to take measures to boost demand through tax cuts or increases in govt. spending.  The Reserve Bank of India (RBI) can use monetary policy to increase the money supply and deliberately induce price rise.  Rising prices provide an essential lubricant for any sustained recovery because businesses increase profits.

Scenario in India  There is no scenario of deflation in the Indian Economy since prices are not falling.

Stagflation  While inflation refers to rising prices in a growing economy, stagflation takes place when price rises are accompanied by a stagnant economy.  Thus in Stagflation: Prices of goods rise. Economy does not exhibit growth.  Hence employment & consumption both dwindle.  At international level, this happened during mid 1970s, when world oil prices rose dramatically, fuelling sharp inflation in developed countries.

Controlling Stagflation  Introducing reforms to help the economy’s growth.  Lowering interest rates by the Central Bank

Scenario in India  India is a growing economy with strong economic growth potential which prevents stagflation.

References  jagath?from_action=save    pdf  measure-to-control-stagflation/31102/  and-deflation-of-economy/8155  deflation.asp  monetary-policy-and-fiscal-policy/31090/  tool-to-control-inflation-is-interest-rate-raghuram-rajan/articleshow/ cms     rates-unchanged-at-his-last-policy-meet-warns-of-inflation-risks/articleshow/ cms