Understanding Inflation in India
“Understanding Inflation in India” is a guest blog written by Surender Bhati.
What is Inflation?
- A rise in the general level of prices of goods and services in an economy over a period of time is known as inflation.
- Inflation can also be defined as a decline in the purchasing power of money.
Types of Inflation:
There are basically 2 types of inflation:
- Demand-Pull Inflation. Demand-pull Inflation is a situation when too much money chases too few goods. In this case demand for goods and services exceeds the supply.
- Cost-Push Inflation.This situation arises when the cost of factors of production goes up.This spreads very rapidly.
Major Causes of Inflation:
- Increase in public expenditure (that is expenditure by the government).
- Excessive population growth.
- Deficit financing (Government finances this deficit either by borrowing from the central bank or through printing of additional currency. In both the cases inflow of money increases which leads to increase in demand and hence results in demand pull inflation.)
- Erratic agricultural growth (The fluctuating monsoon rains impact agricultural productivity –low production causes price rise (inflation) and high production causes prices to fall).
- Industrial production not keeping pace with the rise in demand.
- Upward revision of administered prices. (This results when the cost of production increases or the producers want to increase their profits.
- High rate of indirect tax. Government increase in the indirect taxes results in inflation.
Measures to Control Inflation:
Monetary measures (money supply):
These measures in India are taken by RBI.Monetary measures are divided into 2 types:
Quantitative measures. Term means controlling money supply by controlling the quantity.
Measures taken are:
- Open market operations. RBI sells and purchases the government securities and bonds, basically to control the liquidity of cash in the hands of the people. Selling these reduces money supply & thus inflation.
- Statutory reserve requirements.SLR & CRR (Statutory Liquidity Ratio & Cash Reserve Ratio) are the compulsory reserves of money of commercial banks. SLR is the quantity of liquid assets with the bank itself in terms of precious metals and approved securities. CRR is the percentage of deposits that banks are required to maintain with the RBI. RBI can increase the reserve limit which results in less money with the commercial banks which can be given out for loans.
- Bank rate/Repo rate.Bank rate/ repo rate is the rate at which the RBI gives loans to the commercial banks. Increasing the bank rate/ repo rate will increase the loan rates in the market which results in expensive loans and hence people will avoid taking loans.
Term indicates control of money supply by controlling the quality.
Measures taken are:
- Margin requirements.Asking people to increase the amount of security while taking a loan will dissuade people from taking loan.
- Moral suasion.It is more like lecturing or counseling people and discouraging them to take loans, spend less and invest more. Though this does not work but it’s a measure of controlling money supply.
These measure are taken by the government and are enumerated below.
- Reduction in deficit will lower inflation.
- Government can work on the taxation policies. By increasing the taxes people will be left with less money in hand and hence will spend less.
- Government can curtail its expenditure particularly non plan expenditure which does not promote growth.
- Take measures to increase foreign and private investments by creating suitable environment.
Short term Inflation control measures:
Government can import the necessary goods and distribute them through fair price shops to meet the demand of the people.
Long term Inflation control measures:
Government should promote economic growth, production/procurement to ensure that the demand for goods and services are met in a smooth manner.