What is Inflation
Imagine we had Rs.7 in 2003. One could have purchased a 300 ml Pepsi and gone home happy (excluding the Rs. 2 that shopkeepers charge for refrigerating it).
Fast forward 12 years and on would have to shell out Rs.15 to purchase the same 300ml Pepsi bottle. What happened?
One would think Indra Nooyi has fleeced us, but in reality, the value of money has reduced. This is attributable to inflation.
Inflation is defined as a sustained increase in the general level of prices for goods and services.
Quite literally, the beast of inflation reduces the purchasing power of money.
In recent years, consumer price inflation in India has slowly crept up and reached double digits. The year-on-year change of the CPI-IW has exceeded 5 per cent in every month from early 2006 onwards. This is in contrasts with other emerging economics who have, in general, witnessed low or single digit inflation, especially after the global financial crisis of 2008. Inflation is measured by a variety of indices, like the Consumer Price Index (CPI) and the Wholesale Price Index (WPI). 1. CPI: The Consumer Price Index expresses the current price of a basket of goods and services at present or in any specific year in terms of prices during the same period in the previous year. Most countries, including India, use the CPI as their measure of inflation, which is measured from the consumer 's perspective. 2. WPI: The Wholesale Price Index shows the rise (or fall) of prices of manufactured goods as they leave the factory. Until recently, the Reserve Bank of India (RBI) used the WPI as their measure of inflation. Inflation can mean either an increase in the money supply (i.e. the government printing more money) or an increase in price levels. Increase in money supply will increase prices of products and services because an ample supply of “easy money” will encourage people to spend it fast and increase the demand for all kinds of “goodies”, causing their prices to increase. On the surface, inflation is good, since high demand will encourage companies to increase production and this will improve the GDP. Improved GDP will strengthen the stock market, because investors are always excited about companies’ profitability which has a strong link to higher production throughput and enhanced GDP. Gross Domestic Product – GDP The monetary value of all the finished goods and services produced within a country’s borders in a specific financial year. It includes all of private and public consumption, government outlays, investment and exports less imports that occur within a defined territory on an annual basis. [GDP = C + G + I + NX] Where: - “C” states for private consumption, or consumer spending, in a nation’s economy. “G” is the sum of Government spending. “I” is the sum of all the country’s business spending on capital. “NX” is the Nation’s total net exports, calculated as total exports minus total imports. GDP is commonly used as an indicator of the economic health of a country, as well as to gauge a country’s standard of living. Fiscal and Monetary Policy Over time, …show more content…
Inflation of this type is called demand-pull inflation. Various fiscal and monetary measures are adopted to check this inflation.
There is a two-pronged approach towards controlling the economy, namely, the Fiscal Policy and the Monetary Policy.
Fiscal Policy: Fiscal policy is the means by which a government adjusts its spending levels and tax rates to monitor and influence a nation 's economy. The tax and expenditure programs levied and undertaken by the government are the drivers of the fiscal policy. Monetary Policy: The Monetary Policy is governed by the nation 's central bank (in this instance, the RBI) to control the money supply in the economy to maintain price stability and attain high economic growth. The central bank achieves this by controlling the interest rates.
Monetary policy refers to the adoption of suitable policy regarding interest rate and the availability of credit. Monetary policy is another important measure for reducing aggregate demand to control inflation. As an instrument of demand management, monetary policy can work in two ways:
a. It can affect the cost of credit
b. It can influence the credit