Understanding Inflation
• Inflation is a rise in prices of commodities which result in the decline of purchasing power over time. • Rise in prices can be reflected by upward change in the average prices of a basket of selected goods and services over some period of time. • The rise in prices means that a unit currency effectively buy less than it did in prior periods. e.g. if today you can buy four cood drinks with Rs 200 then maybe after a year, you can only buy two cold drinks with the same amount. So with inflation the value of currency decreases.
Some related terms
• Deflation : general decline in prices when the inflation rate falls below 0%. • Disinflation : a slowing down in the rate (positive) of inflation. Hence in Deflation prices of goods fall, but in Disinflation prices remain increasing but at smaller rate than the previous one.
Does that mean Deflation is beneficial?
Well, the answer is no. Deflation does not indicate that the price of a particular commodity is decreasing only but it refers to the average price all goods or services. It actually indicates that there is less demand ,hence less production of goods and less jobs leading to unemployment. To overcome this we have to bring reflation through monetary policy or Fiscal Policy.
Causes
• Demand-Pull : when Demand for goods/services exceeds production capacity.
• Cost-Push : when the cost of production increases.
•Built-in : when prices rise, then wages rise too in order to maintain living costs.
Its Types
• Mild/ Creeping inflation : prices rise 3% a year or less
•Walking inflation : here prices rise 3-10% a year
•Galloping inflation : rise in prices is more than 10%
•Hyperinflation : prices rises at the rate more than 50%
Reasons why Inflation is good for Economy
| Losers | Winners |
| Savers | Debtors on fixed repayment plans |
| Retirees living on fixed incomes | governments with high public sector debt |
| Workers on fixed incomes | Owners of land and physical assets |
| borrowers on variable rates | Firms who can cut real |
| whole economy – from general economic uncertainty | |
| Exporters less competitive |
• There are two situations when inflation is good –
• When it makes consumers expect prices to continue rise
• when it removes the risk of Deflation.
As a result, stores sell more and factories produce more. They are more likely to hire new workers to meet demand. It creates a virtuous cycle, boosting economic growth.
Hwn inflation becomes harmful
• if inflation is greater than a fixed amount, it becomes dangerous. India expects it to be between 2 to 6%.
Effects
• It reduces the saving capacity of people.
Lending power of banks get negatively affected.
• Business fall short of capital, new capital generation gets reduced.
• Vicious cycle may start, showing shocking trend in Economy.
How is Inflation managed from going to both the Extremes
Here is when RBI comes in action.
Central banks try to keep it at a mild rate. The tool used for this is called “Inflation Targeting”. The range set by RBI is 2 to 6%.
So there are some losers and some winners , but if inflation is under control then it surely helps us.
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