Banking Drive: All About Inflation

Dear Aspirants

IBPS will be conducting the Interview for IBPS PO V 2015 in January 2016. All the aspirants are preparing their best for this. In this regard here is an article on Inflation. I hope this article will help in your preparation.

Inflation: A sustained increase in the general level of prices for goods and services over the time is called inflation. If the price of one good has gone up, it is not inflation; it will be inflation only if the prices of goods have gone up over a period of time.

Types of Inflation

(a) Demand – Pull Inflation: In this type of inflation, prices increase results from an excess of demand over supply for the economy as a whole. Demand inflation occurs when supply cannot expand any more to meet demand; that is, when critical production factors are being fully utilized, also called Demand inflation.

(b) Cost – Push Inflation: This type of inflation occurs, when general price levels rise owing to rising input costs. In general, there are three factors that could contribute to Cost-Push inflation: rising wages increases in corporate taxes, and imported inflation.

Deflation is when the general level of prices falling over period of time, the opposite situation of Inflation. Disinflation on the other hand, refers to a slower rate of inflation.

Stagflation: Stagflation refers to economic condition where economic growth is very slow or stagnant and prices are rising.  The term stagflation was coined by British politician Iain Macleod, who used the phrase in his speech to parliament in 1965.

The side effects of stagflation are increase in unemployment  accompanied by a rise in prices, or inflation. Stagflation occurs when the economy isn’t growing but prices are going up. At international level, this happened during mid-1970s, when world oil prices rose dramatically, fuelling sharp inflation in developed countries.

Hyperinflation: Hyperinflation is a situation where the price increases are too sharp. Hyperinflation often occurs when there is a large increase in the money supply, which is not supported by growth in Gross Domestic Product (GDP).  Such a situation results in an imbalance in the supply and demand for the money.

Headline Inflation: Headline inflation refers to inflation figure which is not adjusted for seasonality or for the often volatile elements of food & energy prices, which are removed in the Core CPI. Headline inflation will usually be quoted on an annualized basis, meaning that a monthly headline figure of 4% inflation equates to a monthly rate that, if repeated for 12 months, would create 4% inflation for the year. It is also known as “top-line inflation”.

Effects of Inflation

There are multi-dimensional effects of inflation on economy at macro and micro levels. Let’s discuss it:

• On Export: When inflation in domestic market Exportable items of an economy gains competitive prices in the world economy. Due to this, the volume of export increases and thus export income increases in the economy.When there is inflation, Export gains benefit.
• On Investment: There is a direct impact of inflation on Investment in the economy. Higher inflation indicates higher demands and suggests entrepreneurs to expand their production level, and, Higher the inflation, lower the cost of loan.
• On Lending: With the rise in inflation, lending institutions feel the pressure of higher lending. Institutions don’t revise the nominal rate of interest as the real cost of borrowing falls by the same percentage with which inflation rises.
• On Creditors and Debtors: Inflation redistributes wealth from creditors to debtors i.e. lenders suffers and borrowers benefit out of inflation.
• On Import: In case of imports, the economy does not get any benefit and loses more foreign currency instead of saving it.
• On Employment: Inflation increases employment in short run.

Indexes related to Inflation in India

WPI

The revised series of WPI is officially launched in 2010. WPI is to calculate the inflation data. Recently, a working group for revision of WPI Number was set up under Abhijit Sen.  Based on the recommendations, the government announced the New Series of Wholesale Price Index .

This index is the most widely used inflation indicator in India.  This is published by the Office of Economic Adviser, Ministry of Commerce and Industry.  WPI captures price movements in a most comprehensive way.   It is widely used by Government, banks, industry and business circles. The current series of Wholesale Price Index has 2004-05 as the base year.   Latest revision of WPI has been done by shifting base year from 1993-94 to 2004-05 on the recommendations of the Working Group set up with Prof Abhijit Sen.

CPI

A consumer price index (CPI) measures changes in the price level of a market basket of consumer goods and services purchased by households. CPI is also used for indexing dearness allowance to employees for increase in prices. CPI is therefore considered as one of the most important economic indicators.

It is the real index for the common people. It reflects the actual inflation that is borne by the individual.  CPI is designed to measure changes over time in the level of retail prices of selected goods and services on which consumers of a defined group spend their incomes. Till January 2012, in India there were only following four CPIs compiled and released on national level. These are:

(1) Industrial Workers (IW) (base 2001)

(2) Agricultural Labourer (AL) (base 1986-87) and

(3) Rural Labourer (RL) (base 1986-87)

(4) Urban Non-Manual Employees (UNME) (base 1984-85)

CPI – IW: It has 260 items with 2001 as base year.

The first three are compiled by the Labour Bureau in the Ministry of Labour and Employment, and the fourth is compiled by Central Statistical Organisation (CSO) in the Ministry of Statistics and Programme Implementation.   These four CPIs reflect the effect of price fluctuations of various goods and services consumed by specific segments of population in the country.

Terms related to Inflation

Core Inflation: The concept is used to estimate the inflation by excluding food and energy prices from the basket of goods and services that represents a typical household’s consumption.   In mid-2012, RBI Governor threw up the conundrum posed by this “Core” inflation by saying “In our economy, where food constitutes nearly 50% of consumption basket and fuel has a weight of 15%, can a measure of inflation that excludes them can be called “Core”.   He suggested that India should move towards developing and using aProducer Price Index (PPI) to gauge inflation more accurately as wholesale price index does not capture the price movement of services and is a hybrid of consumer and producer price quotes.

Urjit Patel Committee report on inflation

The most important recommendations are as follows

• RBI must target inflation only- leave unemployment, growth, exchange rate. The target should be CPI 4% +/- 2%
• RBI fix accountability: At present, monetary policy is made by the governor alone.
• Government to help RBI fight inflation: RBI’s monetary policy fails to yield result because of government’s policies and subsidies, Loan Waiver.

How can government fight inflation?

According to the Economic Survey, It hints the government can fight inflation through:

1. Cut down Fiscal deficit, as per time-bound targets under the Fiscal Responsibility and Budget Management (FRBM) Act.

2. Deregulate power–sector reforms, and generally the move from administered to market-determined prices. This will raise inflation in short term but in long term, it’ll reduce fiscal deficit and thereby reduce inflation.

3. MNREGA doesn’t improve productivity of the agricultural sector commensurately. Raising MNREGA wages => shortage of farm labour => input cost increased, food supplies decreased -> food inflation.

Therefore, MNREGA should be restructured to create productive assets.

4. Agriculture: MSP should be linked with cost of production. FCI’s Procurement should not be open-ended. Bring UREA under NBS (Nutrient Based Subsidy) scheme. Give Fertilizer Subsidy to farmers instead of companies. Some stages charge ~15% mandi tax, and use that money to pay bonus above MSP to farmer (for vote bank politics). This practice must be stopped.

5. FCI should release grains in market to soften food inflation.

6. Government should reduce restrictions on agriculture exports.

What has Government done to fight Inflation?

Government has taken a number of measures to curb inflation, particularly food inflation. Some of the major steps taken by the Government are:

• Higher allocation of rice under Public Distribution System (PDS) and higher allocation of wheat under Open Market Sales Scheme (Domestic) for 2014-15.
• Moderation in increases in the Minimum Support Prices.
• Advisory to the states to allow free movement of fruits and vegetables by delistingthem from the Agricultural Produce Market Committee (APMC) Act.
• Improving availability of essential commodities by facilitating import of various items of mass consumption at zero or concessional import duties together with restriction on export, prescribing stock holding limits under Essential Commodities Act in respect of onion and potato, pulses, edible oil and edible oilseeds and fixing of Minimum Export Price (MEP) for potatoes and onions.

Thanks