IMPACT OF INFLATION ON CAPITAL MARKET

SYNOPSIS 1. Introduction of Inflation. 1.1 Inflation: Definition. 1.2 How to measure Inflation? 1.3 Features of Inflation. 1.4 Types of Inflation. - Creeping Inflation. --Wage inflation. - Walking Inflation. - Running Inflation. - Galloping or Hyper-Inflation. - Cost-Push Inflation. - Demand-pull Inflation. - Built-in Inflation. - Chronic Inflation. -Pricing power inflation. 1.5 Others Terms related to Inflation - Deflation - Disinflation - Inflationary spikes - Reflation

1.6 Causes of Inflation 2. Trace the Effects of Inflation 2.1 Economic Effects of Inflation 2.1.1 Effects on production 2.1.2 Effects of Inflation on Income Distribution. 2.1.3. Effect of Inflation Interest rate. 2.1.4. Effects of Inflation on Globalisation. 2.1.5. Effects of inflation on exchange rate. 2.1.6. Effects on Manufacturers. 2.1.7. Effects of inflation on monetary policy. 2.1.8. Effects of inflation on investment. 2.1.9. Effects of inflation on stock market. 3. Measures to Control Inflation 1) Monetary Measures 2) Fiscal Measures 3) Other Non-monetary Measures 4. Price Rise still pinching Common Man's Poker 5. Tackling Inflation 6. Measures of Inflation 7. Inflation & India (WPI)

8. Indian Scenario - Reasons for inflation in India - Inflation Pressure over the Last Few Months - Inflation in India and other Developed Countries - Inflation during 1980's and 1990's - Global Inflation A Comparison With India 9. Issues in Measuring Inflation 10. An Example of How Inflation Can Be Dangerous (Case) 11. Reserve Bank of India - Introduction - Functions of Reserve Bank of India - Role of RBI - Control Measures of RBI - Monetary Policy - Monetary & Credit Policy 12. Conclusion.

Inflation

OR

SYNOPSIS OF PROJECT

1) Introduction of Inflation
   Inflation: Definition How to measure Inflation? Features of Inflation

2)Types of Inflation
         Creeping Inflation Walking Inflation Running Inflation Galloping or Hyper-Inflation Cost-Push Inflation Demand-pull Inflation Built-in Inflation Chronic Inflation Pricing Power Inflation

3)Others Terms related to Inflation

  Deflation Disinflation

 

Inflationary spikes Reflation

4)Causes of Inflation
   Monetary Factors Non-monetary Factors Structural Factors

5)Trace the Effects of Inflation

       Economic Effects of Inflation Effects on production Effects of Inflation on Income Distribution Effect Of Inflation on Consumption And Welfare EffeSScts of Inflation on Foreign Trade Social and Political Effects Effects On Manufacturers

6) Measures to Control Inflation

    


Monetary Measures Other Non-monetary Measures Price Rise still pinching Common Man's Poker Tackling Inflation Measures of Inflation Inflation & India (WPI)

7) Indian Scenario
     Reasons for inflation in India Inflation Pressure over the Last Few Months Inflation in India and other Developed Countries Inflation during 1980's and 1990's Global Inflation A Comparison With India

8) Issues in Measuring Inflation

 An Example Of How Inflation Can Be Dangerous (Case)

9)Reserve Bank of India

      Introduction Functions of Reserve Bank of India Role of RBI Control Measures of RBI Monetary Policy Monetary & Credit Policy

10)Conclusion
Inflation can be defined

PROJECT REPORT ON IMPACT OF INFLATION ON CAPITAL MARKET BACHELOR OF COMMERCE FINANCIAL MARKETS SEMESTER-V

SUBMITTED TO: UNIVERSITY OF MUMBAI

In partial fulfillment requirements For the Award of degree of Bachelor of Commerce Financial Markets.

PREPARED By LUND JAI .H. ROLL NO:-04

UNDER GUIDANCE OF PROF.POOJA.NAGPAL

SMT. CHANDIBAI HIMATHMAL MANSUKHANI COLLEGE ULHASNAGAR 3

ACKNOWLEDGEMENT

A great teacher is not simple one who imparts knowledge to his student, but one who awakens their interest in it & makes them eager to pursue it for themselves.

This idiom without doubt, fit with PROF.POOJA NAGPAL who has been my teacher, guide & mentor. She widened the sagacity of confidence in me for affecting this project work from the bottom of my heart; I thank her for her precious time that she spent for me.

It is a matter of utmost pleasure to express my indebtedness & deep sense of gratitude, to various persons who extended their maximum help to supply the necessary information for the present theses that became available on account of the most selfless co-operation.

I am grateful to my parents & friends who encouraged & inspired me at every stage of present work by providing immeasurable love affection care & moral support.

Above all, my sincere & heartfelt thanks to almighty god who has always, throughout the preparation of this project reports. LUND JAI .H.

DECLARATION
I, LUND JAI .H. student of B.COM FINANCIAL MARKETS semester (v) (2010-2011) hereby declared that I have completed project on IMPACT OF INFLATION ON CAPITAL MARKET

The information submitted is true and original to the best of my knowledge.

Signature of student

(LUND JAI .H.)

OBJECTIVES

The project on IMPACT OF INFLATION ON CAPITAL MARKET has been prepared with the following objectives:-

To study the significance of various INFLATION towards the conuntry.

To analyze various types of inflation available in the country.

To analyze effects associated with inflation.

To study various causes of inflation.

To gain practical knowledge relating to whole price index.

To suggest some of the remedies to control inflation.

To co-operate with govt. so as to develop the economy.

To analysis different policies and reports of reserve bank of india.

To draw a conclusion and suggestions based on the analysis and

experiences.

Chapter: - 01 After completing this chapter you will come know about:   Inflation: Definition How to measure Inflation? Features of Inflation

01 INTRODUCTION
In todays complex business environment, making capital budgeting decisions are Among the most important and multifaceted of all management decisions as it represents Major commitments of companys resources and have serious consequences on the Profitability and financial stability of a company. It is important to evaluate the proposals rationally with respect to both the economic feasibility of individual projects and the relative net benefits of alternative and mutually exclusive projects.

It has inspired many research scholars and is primarily concerned with sizable investments in long-term assets, with long-term life. The growing of business brings stiff competition which requires a proper evaluation and weightage on capital budgeting appraisal issues viz. differing project life cycle, impact of inflation, analysis and allowance for risk. Therefore financial managers must consider these issues carefully when making capital budgeting decisions. Inflation is one of the important parameters that govern the financial issues on capital budgeting decisions. Managers evaluate the estimated future returns of competing investment alternatives.

Some of the alternatives considered may involve more risk than others. For example, one Alternative may fairly assure future cash flows, whereas another may have a chance of yielding higher cash flows but May also result in lower returns. It is because, apart from other Things, inflation plays a vital role on capital budgeting decisions and is a common fact of life All over the world. Inflation is a common problem faced by every finance manager which complicates the practical investment decision making than others. Most of the managers are concerned about the effects of inflation on the projects profitability. Though a double digit Rate of inflation is a

common feature in developing countries like India; the manager should consider this factor carefully while taking such decisions. In practice, the managers do recognize that inflation exists but rarely incorporate Inflation in the analysis of capital budgeting, because it is assumed that with inflation, both net revenues and the project cost will rise proportionately, therefore it will not have much impact.

Meaning:Inflation (increase in money supply) increases the prices of goods because through inflation, the value of the currency goes down. It practically debases the currency. Imagine rare baseball cards. They have high value. But if you create more baseball cards, its value will go down as it is easier for people to get these baseball cards which are not so rare anymore.

Inflation (increase in money supply) happens when central banks print money out of thin air (through injection of artificial credit, artificially lower interest rates, etc.). This is the reason why governments like to get out of the gold standard or any type of commodity based currency because they could inflate (increase the money supply) anytime they want. If a currency is backed by gold or any commodity, it prevents the government from artificially inflating the currency as the supply of money is based on the supply of what it is backed by (i.e., gold, silver).

Inflation (increase in money supply), aside from its effect on prices, also affects people in another way. Inflation (increase in money supply) only benefits the first group of people who receive the newly printed money. The people who get the money first benefits because they get to spend the newly printed money during the time when prices has not gone up yet as the newly printed money hasn't deeply circulated the market. Once the money trickles down to the economy, more money is now available for spending, which debases the currency thus jacking up the prices of goods. Prices of goods increase because more money is now in circulation which was printed out of thin air. The value of the currency is now lower than before. Just like baseball cards.

On the other hand, the people who don't get the money first will then hurt because the prices of goods go up even before their salaries go up. So they will be spending more money for higher priced goods for the same level of income before they even get a salary increase.

So basically, inflation is not an increase in prices of goods. Inflation is the increase in money supply. The increase in prices of goods is a consequence of inflation. Now, I would say that the common reason for inflation (increase in money supply) is the central bank's "printing press".

Definitions:y According to Crowther, Inflation is a state in which the value of money is failing,

i.e., prices is rising. y According to Pigou, Inflation takes place when money income is expanding

relatively to the output of work done by the productive agents for whom it is the payment. y The term "inflation" originally referred to increases in the amount of money in

circulation, and some economists still use the word in this way. However, most economists today use the term "inflation" to refer to a rise in the price level. An increase in the money supply may be called monetary inflation, to distinguish it from rising prices, which may also for clarity be called 'price inflation'.Economists generally agree that in the long run, inflation is caused by increases in the money supply. However, in the short and medium term, inflation is largely dependent on supply and demand pressures in the economy.

Features: The quantity of money is increasing but the production is static and not increasing.  The quantity of money is stable but the production is declining.  If the quantity of money is declining and the production is also declining but decline in production is higher than the decline in the quantity of money.  If the quantity of money is increasing and the volume of production is declining.  If the quantity of money is in excess of demand or requirements.  If the quantity of money as well as production is increasing but rate of increase in production is lesser than the rate of increase in the quantity of money.

Chapter: - 02 After completing this chapter you will come know about:         Creeping Inflation Walking Inflation Running Inflation Galloping or Hyper-Inflation Cost-Push Inflation Demand-pull Inflation Built-in Inflation Chronic Inflation Pricing Power Inflation

Types of Inflation: Creeping Inflation:When prices are gently rising, it is referred as Creeping Inflation. It is the mildest form of inflation and also known as a Mild Inflation or Low Inflation. According to R.P. Kent, when prices rise by not more than (up to) 3% per annum (year), it is called Creeping Inflation.

 Demand Pull Inflation:This occurs when AD increases at a faster rate than AS. Demand pull inflation will typically occur when the economy is growing faster than the long run trend rate of growth. If demand exceeds supply, firms will respond by pushing up prices.

 Cost Push Inflation:Cost Push Inflation occurs when there is an increase in the cost of production for firms causing Aggregate Supply to shift to the left. Cost push inflation could be caused by rising energy and commodity prices.

 Wage Push Inflation:Rising wages tend to cause inflation. In effect this is a combination of demand pull and cost push inflation. Rising wages increase cost for firms and so these are passed onto consumers in the form of higher prices. Also rising wages give consumers greater disposable income and therefore cause increased consumption and AD. In the 1970s, trades unions were powerful in the UK. This helped cause rising nominal wages; this was a significant factor in causing inflation

 Walking Inflation:When the rate of rising prices is more than the Creeping Inflation, it is known as Walking Inflation. When prices rise by more than 3% but less than 10% per annum (i.e between 3% and 10% per annum), it is called as Walking Inflation. According to some economists, walking inflation must be taken seriously as it gives a cautionary signal for the occurrence of Running inflation. Furthermore, if walking inflation is not checked in due time it can eventually result in Galloping inflation.

 Chronic Inflation:If creeping inflation persist (continues to increase) for a longer period of time then it is often called as Chronic or Secular Inflation. Chronic Creeping Inflation can be either Continuous (which remains consistent without any downward movement) or Intermittent (which occurs at regular intervals). It is called chronic because if an inflation rate continues to grow for a longer period without any downturn, then it possibly leads to Hyperinflation.

 Running Inflation:A rapid acceleration in the rate of rising prices is referred as Running Inflation. When prices rise by more than 10% per annum, running inflation occurs. Though economists have not suggested a fixed range for measuring running inflation, we may consider price rise 10% to 20% per annum (double digit inflation rate) as a running inflation.

 Galloping Inflation:-

According to Prof. Samuelson, if prices rise by double or triple digit inflation rates like 30% or 400% or 999% per annum, then the situation can be termed as Galloping Inflation. When prices rise by more than 20% but less than 1000% per annum 20% to 1000% per annum), galloping inflation occurs. It is also referred as jumping inflation. India has been witnessing galloping inflation since the second five year plan period.

 Hyperinflation:Hyperinflation refers to a situation where the prices rise at an alarming high rate. The prices rise so fast that it becomes very difficult to measure its magnitude. However, in quantitative terms, when prices rise above 1000% per annum (quadruple or four digit inflation rate), it is termed as Hyperinflation. During a worst case scenario of hyperinflation, value of national currency (money) of an affected country reduces almost to zero. Paper money becomes worthless and people start trading either in gold and silver or sometimes even use the old barter system of commerce. Two worst examples of hyperinflation recorded in world history are of those experienced by Hungary in year 1946 and Zimbabwe during 20042009 under Robert Mugabe regime.

 Build-In Inflation:Vicious cycle of Build-in inflation is induced by adaptive expectations of workers or employees who try to keep their wages or salaries high in anticipation of inflation. Employers and Organizations raise the prices of their respective goods and services in anticipation of the workers or employees' demands. This overall builds a vicious cycle of rising wages followed by an increase in general prices of commodities. This cycle, if continues, keeps on accumulating inflation at each round turn and thereby results into what is called as Build-in inflation.

 Sect oral Inflation:It occurs when there is a rise in the prices of goods and services produced by certain sector of the industries. For instance, if prices of crude oil increase then it will also affect all other sectors (like aviation, road transportation, etc.) which are directly related to the oil industry. For e.g. If oil prices are hiked, air ticket fares and road transportation cost will increase.

 Pricing Power Inflation:It is often referred as Administered Price inflation. It occurs when industries and business houses increase the price of their goods and services with an objective to boost their profit margins. It does not occur during a financial crisis and economic depression, and is not seen when there is a downturn in the economy. As Oligopolies have the ability to set prices of their goods and services it is also called as Oligopolistic Inflation.

Chapter: - 03

After completing this chapter you will come know about:-

Others Terms related to Inflation

    Deflation Disinflation Inflationary spikes Reflation

Deflation
 Concept of deflation:A decline in general price levels, often caused by a reduction in the supply of money or credit. Deflation can also be brought about by direct contractions in spending, either in the form of a reduction in government spending, personal spending or investment spending. Deflation has often had the side effect of increasing unemployment in an economy, since the process often leads to a lower level of demand in the economy opposite of inflation.

In economics, deflation is a decrease in the general price level of goods and services. Deflation occurs when the inflation rate falls below 0% (a negative inflation rate). This should not be confused with disinflation, a slow-down in the inflation rate (i.e. when inflation declines to lower levels). Inflation reduces the real value of money over time; conversely, deflation increases the real value of money the currency of a national or regional economy. This allows one to buy more goods with the same amount of money over time.

 Concept of Disinflation:Disinflation is a decrease in the rate of inflation a slowdown in the rate of increase of the general price level of goods and services in a nation's gross domestic product over time. It is the opposite of reflation.If the inflation rate is not very high to start with, disinflation can lead to deflation decreases in the general price level of goods and services. For example if the annual inflation rate one month is 5% and it is 4% the following month, prices disinflated by 1% but are still increasing at a 4% annual rate. If the current rate is 1% and it is the -2% the following month, prices disinflated by 3% and are decreasing at a 2% annual rate.

There is widespread consensus among economists that inflation is caused by increases in the supply of money available for use in a nation's economy. Inflation can also occur when the economy 'overheats' because of excess aggregate demand (this is called demand-pull inflation). The causes of disinflation are the opposite, either a decrease in the growth rate of the money supply, or a business cycle contraction (recession). During a recession, competition among businesses for customers becomes more intense, and so retailers are no longer able to pass on higher prices to their customers. In contrast, deflation occurs when prices are actually dropping.

 Concept of Inflationary Spikes:Inflationary spikes` occur when a particular section of the economy experiences a sudden price rise possibly due to external factors. For example: If a large amount of crop is destroyed, the value of the remaining crop will rise sharply. Inflationary spikes occur when a particular section of the economy experiences a sudden price rise possibly due to external factors. For example: If a large amount of crop is destroyed, the value of the remaining crop will rise sharply. This will distort the overall measure of inflation within the economy (Headline inflation). Core inflation seeks to avoid the influence of these spikes by excluding areas of the economy such as food and energy which may be susceptible to such shocks.

 Concept of Reflation:A fiscal or monetary policy, designed to expand a country's output and curb the effects of deflation. Reflation policies can include reducing taxes, changing the money supply and lowering interest rates. The term "reflation" is also used to describe the first phase of economic recovery after a period of contraction. Reflation policy has been used by American governments, to try and restart failed business expansions since the early 1600s. Although almost every government tries in some form or another to avoid the collapse of an economy after a recent boom, none have ever succeeded in being able to avoid the contraction phase of the business cycle. Many academics actually believe government agitation only delays the recovery and worsens the effects.

Chapter: - 04 After completing this chapter you will come know about:Causes of inflation: Over- Expansion of Money Supply: Many a times a remarkable degree of correlation between the increase in money and rise in the price level may be observed. The Central Bank (Indias RBI) should maintain a balance between money supply and production and supply of goods and services in the economy. Money supply exceeds the availability of goods and services in the economy, it would lead to inflation. 

Increase in Population:Increase in population leads to increased demand for goods and services. If supply of commodities is short, increased demand will lead to increase in price and inflation.

 

Expansion of Bank Credit: Rapid expansion of bank credit is also responsible for the inflationary trend in a country. Deficit Financing: Deficit financing means spending more than revenue. In this case government of India accepts more amount of money from the Reserve Bank India (RBI) to spend for undertaking public projects and only the government of India can practice deficit financing in India. The high doses of deficit financing which may cause reckless spending, may also contribute to the growth of the inflationary spiral in a country.

High Indirect Taxes: Incidence of high commodity taxation, prices tend to rise on account of high excise duties imposed by the Government on raw materials and essentials.

Black Money: It is widely condemned that black money in the hands of tax evaders and black marketers as an important source of inflation in a country. Black money encourages lavish spending, which causes excess demand and a rise in prices.

Poor Performance of Farm Sector:If agricultural production especially food grains production is very low, it would lead to shortage of food grains, will lead to inflation.

Other reasons :-

Other reasons include the following: 1) Capital bottleneck, entrepreneurial bottlenecks, infrastructural bottlenecks and foreign exchange bottlenecks. 2) When the government of a country print money in excess, prices increase to keep up with the increase in currency, leading to inflation. 3) Increase in production and labor costs, have a direct impact on the price of the final product, resulting in inflation. 4) When countries borrow money, they have to cope with the interest burden. This interest burden results in inflation. 5) High taxes on consumer products, can also lead to inflation. 6) Demands pull inflation, wherein the economy demands more goods and services than what is produced. 7) Cost push inflation or supply shock inflation, wherein non availability of a commodity would lead to increase in prices.

Chapter: - 05 After completing this chapter you will come know about:-

IMPACT OF INFLATION: Problems of inflation  Effects on production.  Effects of Inflation on Income Distribution.  Effect of Inflation Interest rate.  Effects of Inflation on Globalisation.  Effects of inflation on exchange rate.  Effects on Manufacturers.  Effects of inflation on monetary policy.  Effects of inflation on investment.  Effects of inflation on stock market. Introduction
Inflation has a positive impact and negative effects, depending on whether or not severe inflation. If inflation is mild, it has a positive influence in the sense to stimulate the economy better that is to increase national income and get people excited to work, save and invest. Conversely, in times of severe inflation, which in the event of uncontrolled inflation (hyperinflation), the economic situation became chaotic and felt sluggish economy. People are not excited about working, saving, or make investment and production because prices are rising rapidly. The recipients of fixed incomes such as civil servants or private employees and workers will also be overwhelmed bear and keep up the price so that their lives become increasingly degenerate and collapsed from time to time. For people who have a fixed income, inflation is very detrimental. We take the example of a retired civil servant in 1990. In 1990, his pension is adequate to meet the necessities of life, but

in the year 2003-or thirteen years later, the purchasing power of money may be only a half. This means that retirement money is no longer sufficient to meet their needs. Conversely, people who rely on income based benefits, such as businessmen, not impaired by the existence of inflation. So it is with employees who work in companies with salaries following the rate of inflation. Inflation also causes people reluctant to save because of the currency goes down. Indeed, savings earn interest, but if the interest rate above inflation, the value of money is still declining. When people are reluctant to save money, business and investment will be difficult to develop. Because, to grow the business need of funds from bank savings obtained from the public. For people who borrow money from banks (the debtor), inflation is beneficial, because at the time of payment of debts to creditors, the value of money is lower than at the time of borrowing. Instead, the lender or the lender will lose money because the value of money returns lower than at the time of borrowing. For producers, inflation can be beneficial if the income earned is higher than the increase in production costs. When this happens, producers will be forced to double its production (usually happens in big business). However, when inflation led to rising production costs and eventually harming producers, then producers are reluctant to continue production. Manufacturers could stop production for a while. In fact, if not able to follow the rate of inflation, the business may be bankrupt manufacturer (usually occurs in small businesses). In general, inflation can result in reduced investment in a country, pushing up interest rates, encouraging speculative investment, the failure of development, economic instability, balance of payments deficits, and declining levels of life and community welfare.

THE PROBLEMS DUE TO INFLATION WOULD BE:

 When the balance between supply and demand goes out of control, consumers could

change their buying habits, forcing manufacturers to cut down production.

 The mortgage crisis of 2007 in USA could best illustrate the ill effects of inflation.

Housing prices increases substantially from 2002 onwards, resulting in a dramatic decrease in demand.
 Inflation can create major problems in the economy. Price increase can worsen the

poverty affecting low income household,

 Inflation creates economic uncertainty and is a dampener to the investment climate

slowing growth and finally it reduce savings and thereby consumption.

 The producers would not be able to control the cost of raw material and labor and hence

the price of the final product. This could result in less profit or in some extreme case no profit, forcing them out of business.
 Manufacturers would not have an incentive to invest in new equipment and new

technology.
 Uncertainty would force people to withdraw money from the bank and convert it into

product with long lasting value like gold, artifacts It has been reported that the manufacturing capacity in India is running around 95 per cent, which usually means it is running at full capacity. Therefore, when the price of manufactured products is increasing, it means that demand is usually higher than supply and that is a clear case of demand-pull inflation. On the primary goods front, which consists of fruits, vegetables, food-grains etc, it is not that straight-forward. It has certainly been all over the news that the prices of fruits and vegetables are increasing and a trip to the supermarket or local grocery shop will testify to that. Although it is a clear case of demand-pull inflation, on the other, it is also a bit of a supply shock when one considers the fact that there is an abnormally high percentage of fruits and vegetables that goes to waste because of the lack of cold-storage facilities. Some estimates say 50 per cent of produce goes to waste and that is a conservative number.

The fuel price hike is a straight example of cost push inflation. When OPEC (The Organization of the Petroleum Exporting Countries) was formed, it squeezed the supply of oil and this caused oil prices to rise, contributing to higher inflation. Since oil is used in every industry, a sharp rise in the price of oil leads to an increase in the prices of all commodities. The in depth problems due to inflation would be:  When the balance between supply and demand goes out of control, consumers could change their buying habits, forcing manufacturers to cut down production.  Inflation can create major problems in the economy. Price increase can worsen the poverty affecting low income household.  Inflation creates economic uncertainty and is a dampener to the investment climate slowing growth and finally it reduce savings and thereby consumption.  The producers would not be able to control the cost of raw material and labor and hence the price of the final product. This could result in less profit or in some extreme case no profit, forcing them out of business.  Manufacturers would not have an incentive to invest in new equipment and new technology.  Uncertainty would force people to withdraw money from the bank and convert it into product with long lasting value like gold, artifacts.  The imbalances inflation has created in the Indian economy: It has created a new rich class in social and political lives who are corrupt themselves and also corrupt the overall society.  The increased prices reduced the capacity to save and people preferred present consumption to future consumption.  It has provided protection and subsides to industries which bred inefficiency.  It has lead to misallocation of resources due to distortion of relative prices and finally a redistribution of wealth from the poor to the rich.  It disturbs balance of payments.

Economic Effects of Inflation

Inflation and the economy of a country are closely related. The effect on the economy of any country is not immediate or it does not affect the economy overnight. There is a cumulative effect. Several such changes build up to bring about a big change. The economy of a country is affected by inflation in a number of ways.

Inflation and the economy both influence all the major macroeconomic indicators of a country. The various macroeconomic indicators include the following:
 Gross domestic product or GDP  Producer price index (industrial)  Consumer price indices  Industrial production  Capital Investment  Agricultural production  Export  Import  Demography  Debt

Inflation not only affects the macroeconomic indicators, it affects the living standards of the people. As the percentage of inflation increases, the cost of all commodities also increases. However, the same is not true for the salaries or the wages. It results in a mismatch of income and expenses. As a result, the people are immensely impacted by these changes. The exchange rates of all currencies also change. This in turn influences trade. When exchange rates are affected, the interest rates cannot be far behind. Inflation and its effect on economy is enormous. In other words, all events are interlinked and the entire economic cycle gets upset. Inflation and its effect on economy may be of two types:
y y

Expected inflation Unexpected inflation

Effect on production:-

During inflation producers try to minimize the risk. Hence a lot of production potential is sacrificed. Goods that are more durable are produced more; as compared to goods that are less durable. This alters the pattern of production. Inflation gives rise to more speculation and hoarding, which is bad for the economy. The basic knowledge about the market tends to lose its importance, and producers and consumers have to update themselves constantly. Production and economic growth gets seriously retarded, as the products, at high prices, may fail to find a buyer. Wrong anticipations and misallocation of resources lead to loss of profit and growth.


Effect of Inflation on Income Distribution:-

Inflation redistributes income, because prices of all factors do not rise in the same proportion. Since the effect of inflation on the incomes of different classes of earners varies, there are serious social consequences. During inflation, the distributive share accruing to the profiteers increases more then that of wage earners or fixed income earners, such as their renters class. All producers, traders and speculators gain during inflation because of the emergence of windfall profits which arise, because prices rise at a faster and greater rate than the cost of production; wages, interest and rent do not increase rapidly, and are more or less fixed. i) Debtors and creditors: Debtors generally gain and creditors lost during inflation. Gain accrues to a debtor because he repays loans at a time when the purchasing power of money is lower than when it was borrowed. The creditor, on the other hand, is a loser during inflation, since he received, in effect, less in goods and services than he would have received in times of low prices. Thus, borrowers who borrowed funds prior to inflation stand to gain by inflation, and creditors who lent funds lose. ii) Business community: Inflation is welcomed by entrepreneurs and businessmen because they stand to profit by rising prices. They find that the value of their inventories and stock of goods is rising in money terms. They also find that prices are rising faster than the costs of production, so that their profit margin is greatly enhanced. The business community, therefore, gets

supernormal profit during periods of inflation, and those profits continue to increase as long as prices rise. iii) Fixed income groups: Inflation hits wage earners and salaries people very hard. Although wage earners, by the grace of trade unions, can chase galloping prices, they seldom win the race. Since wages do not rise at the same rate, and at the same time, as the general price level, the cost of living index rises, and the real income of the wage earner decreases. Moreover, in trying to push up wages to sustain their real income wage earners bring about cost-push inflation, and in the process worsen their position. Those who depend exclusively on fixed salaries for a living are severally affected by inflation. Among these people are teachers, clerks, government servants, pensioners and persons living on past savings. iv) Investors: Those who invest in debentures and fixed interest bearing securities, bonds, etc. lose during inflation. However, investors in equities benefit because more dividend is yielded on account of high profits made by joint stock companies during inflation. v) Farmers: Farmers are benefited during inflation because of two factors. a) The prices of farm products increase, and b) Increase in the cost of production lags behind the rise in the prices. Farmers who produce food grains and other highly inflation sensitive products are benefited the most. Farmers in debts repayments repay their old debts along with the rate of interest as they get profits due to rising prices. They are further benefited as debtors as they pay back lower purchasing power to the creditors, inflation, thus provides double advantages to the farmers. 3) Other Effect: Inflation leads to a number of other effects which are discussed as under : i) Government: Inflation affects the government in various ways. It helps the government in financing its activities through inflationary finance. As the money income of the people increases, the government collects that in the form of taxes on incomes and commodities. So the

revenues of the government increase during rising prices. Moreover, the real burden of the public debt decreases when prices are rising. ii) Balance of payments: Inflation involves the sacrificing of the advantages of international specialization and division of labor. It adversely affects the balance of payments of a country. When prices rise more rapidly in the home country than in foreign countries, domestic products become costlier compared to foreign products. This tends to increase imports and reduce exports, thereby making the balance of payments unfavorable for the country. iii) Exchange rate: When prices rise more rapidly in the home country than in foreign countries, it lowers the exchange rate in relation to foreign currencies. iv) Collapse of the monetary system: It hyperinflation persists and the value of money continues to fall many times in a day, it ultimately leads to the collapse of the monetary system, as happened in Germany after world war I. v) Social: Inflation is socially harmful. By widening the gulf between the rich and the poor, rising prices create discontentment among the masses. Pressed by the rising cost of living, workers, resort to strikes which lead to loss in production. Lured by Profit, people resort to hoarding, black-marketing, adulteration, manufacture of substandard commodities, speculation, etc. Corruption spreads in every walk of life. All this reduces the efficiency of the economy. vi) Political: Rising prices also encourage agitations and protests by political parties opposed to the government. And if they gather momentum and become unhandy they may bring the downfall of the government. Many government have been sacrificed at alter of inflation.

Effect inflation On producers:-

The increase was the fourth in consecutive months since the index resumed its ascent in December last year, and the rate was the highest in the 12-month period to March 2011.The high annual rate of increase in prices received by domestic producers continues to reflect the substantial year-on-year impact of utility prices, which were hiked sharply in June 2010 following demands by producers in the sector for price-adjustments.Producer inflation in the utilities sector was 71.96% year-on-year, though the increase between February and March was a marginal 0.01%. Mining and quarrying recorded inflation of 32.27%, while manufacturing inflation was a lower 11.61%. Government Statistician, Dr. Grace Bediako, disclosed that the highest monthly inflation of 4.83% was recorded in the mining and quarrying sector due mainly to higher prices for gold. The month-on-month rate for all industries was 0.91%, she said.Compared to February, this was a lower monthly increase, and given the considerably lopsided effect of utility prices on the index, the increasing annual rate of producer price inflation may not portend a similar trajectory for consumer inflation in the coming months. March consumer inflation dipped marginally to 9.13% as stable food prices helped turn the tide of increases that had been occasioned by January's petroleum price revisions. Yet, as a cost-ofdoing-business indicator, the persistently double-digit producer inflation figures support longstanding concerns within industry about a costly business environment as domestic producers contend with cheap imports, high financing costs and currency risks that threaten the stability of raw-material prices.

Effect of inflation Interest Rate:-

Interest and inflation are key to investing decisions, since they have a direct impact on the investment yield. When prices rise, the same unit of a currency is able to buy less. A sustained deterioration in the purchasing power of money is called inflation. Investors aim to preserve the value of their money by opting for investments that generate yields higher than the rate of inflation. In most developed economies, banks try to keep the interest rates on savings accounts

equal to the inflation rate. However when the inflation rate rises, companies or governments issuing debt instruments would need to lure investors with a higher interest rate.

 The Relationship between Interest and Inflation

Inflation is an autonomous occurrence that is impacted by money supply in an economy. Central governments use the interest rate to control money supply and, consequently, the inflation rate. When interest rates are high, it becomes more expensive to borrow money and savings become attractive. When interest rates are low, banks are able to lend more, resulting in an increased supply of money.
Alteration in the rate of interest can be used to control inflation by controlling the supply of money in the following ways:

 A high interest rate influences spending patterns and shifts consumers and businesses from borrowing to saving mode. This influences money supply.  A rise in interest rates boosts the return on savings in building societies and banks. Low interest rates encourage investments in shares. Thus, the rate of interest can impact the holding of particular assets.  A rise in the interest rate in a particular country fuels the inflow of funds. Investors with funds in other countries now see investment in this country as a more profitable option than before

 Inflation and Interest Rates: Effect on the Time Value of Money

Inflation has a significant impact on the time value of money (TVM). Changes in the inflation rate (whether anticipated or actual) result in changes in the rates of interest. Banks and companies anticipate the erosion of the value of money due to inflation over the term of the debt instruments they offer. To compensate for this loss, they increase the interest rates.

The central bank of a country alters interest rates with the broader purpose of stabilizing the national economy. Investors need to keep a close watch on interest and inflation to ensure that the value of their money increases over time.

 Effect of inflation Exchange Rate:Inflation and exchange rates, both determine, if a nation is likely to be economically stable or not. For several years, exchange rates have caused much debate and different opinions were expressed with regard to exchange rates.

Inflation and its effects on exchange rates can also be ascertained from the following facts. In earlier days, it was suggested by a majority of the economists to peg a particular currency or to dollarize currency of a country. Nations (emerging countries) were used to having a fixed type of exchange rate. Every effort was made to keep the exchange rate fixed because a floating exchange rate was feared to cause inconvenience in trading. With the advent of the concept of inflation targeting and exchange rates, which are flexible, the scenario has changed. More and more countries are moving away from the fixed exchange rates. This transition is taking place, when most of the nations are adopting inflation targeting as a means of conducting various monetary policies. In many countries, the nominal exchange rate was used as a means to bring down inflation.

 Inflation and exchange rates- value of currency

The exchange rates are essential macroeconomic variables. It affects inflation, trade (imports and exports) and various other economic activities of a nation. If the rate of inflation remains low for a considerable period of time, the value of currency rises. This occurs due to increase in the purchasing power. Switzerland, Japan and Germany were three countries, the inflation rates of, which were low during the late twentieth century. Other countries to follow suit were Canada and United States of America. The countries, having higher rates of inflation observed

depreciation in their currency. On the other hand, countries with low rates of inflation did not observe this trend at least for the time being. In the event when a nation is aware of a possible rise in inflation, it can take measures accordingly. Exchange rates may also be affected by the type of inflation prevailing in the economy. Inflation may be:
 Cost push inflation  Demand pull inflation

We discover a close association between inflation and exchange rates, which affect almost all sectors of the economy.


Effect of inflation Globalization:-

Many economists hold different views about inflation and globalization. There are various schools of thought. With regard to inflation and globalization, some economists say that globalization encourages inflation, while few others express their view on the contrary. Globalization has impacted inflation in different ways. Globalization basically means the opening up of an economy. Whenever, the tariff barriers are lowered and trade barriers are removed, it means that goods from other countries can be availed by residents of another country. There is extensive exchange of goods and services. This is done by lowering the tariff and bringing down other obstacles. What is to be seen next is the role played by inflation and globalization in the economy of a country.

 Inflation and globalization- Different views:Domestic inflation is impacted by many global factors. Owing to trade expansion there might be domestic inflation. This happens because trade expansion depends to a large extent on cost of goods, which are imported. Another factor, which is taken into consideration is competitive pressure brought forth by globalization. The costs of some goods are internationally integrated. Pressures created for utilizing resources in economies of foreign countries could influence

domestic inflation. Few economists feel that globalization does not affect the rate of inflation. This is because the changes, which globalization has brought forth affect relative costs of services and goods. On the other hand, there are yet others, who feel inflation is after all the change in the overall price level. This can be determined by monetary policies. This (monetary policies affecting inflation) holds true for long term commitments. With regard to short or medium run commitments, it may not hold true.

 Effect of inflation Investment

Inflation, as we know reduces the purchasing power of individuals. Due to inflation, the cost of goods increases and people have to spend more for buying a particular commodity for, which they had to pay less early. Inflation inflicts injury to the common man, who lives on limited fixed income. Even if they have some savings, they are required to use the money to compensate for inflation. Consequently, they are left with little money to fund for investments. The more an individual routes the savings for investments, the greater are the chances for boosting growth in the economy.

 Inflation and investment- an overview:

Inflation and investment are required to be more compatible to facilitate growth in the trading sector of a country, thereby facilitating economic headway. Inflation affects exchange rates, interest rates among various other economic indicators. As the exchange rates get affected and start varying, predicting future trends in the value of currencies become difficult. A certain amount of uncertainty remains and this de motivates the trading partners. The volatility, which is associated with inflation, affects different production activities in the market. It also enhances the hazards associated with this volatility. Inflation and investment compatibility is desirable, not only for matters related to trade but also for other investment tools like market shares, bonds and stocks. However, if one invests in stocks, the individual is not required to lose sleep. The reason being, the revenues earned by a company over a period of time is likely to compensate for the rise in the rate of inflation. When

inflation occurs, borrowers as well as lenders do not opt for long term commitments.

The worst affected are the retired individuals. To execute retirement schemes, a careful analysis of the market conditions need to be carried out. Due to inflation, predicting future trends becomes very difficult. With rise in inflation, costs of goods an increase. To meet the requirements, one has to depend on the savings and this leads to the erosion of actual savings of the individual.

 Inflation and investment- measures to counteract the ill effects of inflation:

Treasury Inflation Protected Securities (TIPS) is a bond or a treasury note, which prevents the returns (on investments) of individuals from being gnawed away by inflation.

 Effect of inflation on Stock Market

Inflation is a state in the economy of a country, when there is a price rise of goods as well as services. To meet the required price rise, individuals have to shell out more than is presumed. With increase in inflation, every sector of the economy is affected. Ranging from unemployment, interest rates, exchange rates, investment, stock markets, there is an aftermath of inflation in every sector. Inflation is bound to impact all sectors, either directly or indirectly. Inflation and stock market have a very close association. If there is inflation, stock markets are the worst affected.

 Inflation and stock market- the logistics:

Prices of stocks are determined by the net earnings of a company. It depends on how much profit, the company is likely to make in the long run or the near future. If it is reckoned that a company is likely to do well in the years to come, the stock prices of the company will escalate. On the other hand, if it is observed from trends that the company may not do well in the long run, the stock prices will not be high. In other words, the prices of stocks are directly proportional to the performance of the company. In the event when inflation increases, the company earnings (worth) will also subside. This will adversely affect the stock prices and eventually the returns.

Effect of inflation on stock market is also evident from the fact that it increases the rates if interest. If the inflation rate is high, the interest rate is also high. In the wake of both (inflation and interest rates) being high, the creditor will have a tendency to compensate for the rise in interest rates. Therefore, the debtor has to avail of a loan at a higher rate. This plays a significant role in prohibiting funds from being invested in stock markets. When the government has enough funds to circulate in the market, the cost of goods, services usually go up. This leads to the decrease in the purchasing power of individuals. The value of money also decreases. In a nut shell, for the economy to flourish, inflation and stock market ought to be more conforming and predictable.

 Effect of inflation on manufacturers:Manufacturing inflation, with the largest weight of 69.75% in the index's computation, rose to 11.61% in March from 11.16% in February.Publishers recorded the highest inflation among manufacturers with an annual increase of 35.64%, followed by manufacturers of electrical machinery and apparatus, whose prices went up by 34.81%.

Consumer-goods manufacturers saw varied rates within the main sub-groups: food and beverage producers saw 9.04% inflation, compared to 8.8% in February; protein, fruit, vegetables and cooking oil producers experienced an annual decline of 0.22% in prices; and dairy-product

manufacturers saw stable inflation of 13.24%.Producer inflation for other food-product manufacturers was 27.97%, higher than the previous month's figure of 25.63%. Textile manufacturing also saw annual inflation of 20.22%. Inflation, on the other hand, can also be quite destructive. For example, a slow in inflation make importers' products cheaper, whereas domestic manufacturers' product prices remain the same. A sudden slow in inflation causes lower imported product prices, meaning two things. First, because of the lower import prices, more people will by imports opposed to domestically manufactured products. This hurts domestic production, which in turn may result in rising unemployment (domestic producers fire employees to keep up with shrinking sales revenue) Robin Johnson, head of the Industrial Engineering practice at Eversheds LLP, gives his take on the affect of rising input prices. Inflation in commodity costs could seriously damage what has to date been a strong recovery in the manufacturing sector. The question now is whether the lean processes put in place during the recession can help to offset some of the cost, or whether the costs can be passed on to Original Equipment Manufacturers and then on to consumers. If the costs cant be passed on in whole, the manufacturers margins and therefore revenue lines will in turn be affected. This has created a perfect storm. Manufacturers have had to make cutbacks, and although demand has continued to grow, albeit fragile, the scarceness of commodities, which was an issue even before the recession, has started to take on an even greater significance now. As a result the importance of control of commodities in emerging economies such as Africa will become both a political, economic and trade DOHA concern. Obtaining long-term secure supply contracts could therefore be the biggest issue facing manufacturers in the next 12 months. Take or pay contracts may become prevalent, meaning that you take or, if you dont, you are required to pay anyway. Sole or exclusive or regional supply chains will be key. In the longer term I can see this issue extending outside of areas such as steel and energy, and starting to impact on commodities such as food and water. We could even see the industry

reverting back to the 1960s, in which local stockpiling became the norm, as todays logistics costs combined with the impact of climate change requires suppliers to avoid reliance on long supply chains and dramatically reduce the gap between themselves and their customers.

 Effect on Distribution of Wealth

Inflation has its own effects on the aggregate demand, which in turn puts its effects on total production and income. Following are the several effects of inflation.

1. As demand for money increases, its price, namely the rate of interest, rises. That brings down the investment. 2. Inflation reduces the total output of the community. 3. As consumers feel insecure during periods of inflation, their desire to save increases. Thus, propensity to save rises. 4. As the value of money falls, and consequently the real value of wealth in the hands of consumers, spending made by the consumers fall. 5. As goods fetch higher prices in the domestic market, it discourages export, and to an extent encourages imports. More imports deplete the foreign exchange reserve of a country. 6. As profit expectation remains high due to high prices, it encourages investment in some way. Redistribution of income and wealth take place during periods of inflation. Rate of growth of the economy in also reduced. During inflation people do not want to hold the money, whose value is falling. So there may be a conversion into other assets, in the form of bonds, securities or gold and silver. Wages and profits increase relatively more that rent and interest. People belonging to the fixed income group are the major losers. Their earnings and accumulated savings diminish or get eroded. Debtors try to pay back their past debts in currencies which are of very little value. Low-income groups suffer the most during inflation.

Effect of inflation on Employment

Inflation and unemployment are inter-related. A near full-employment situation with stability of prices is the aim. However measures to control inflation create unemployment, whereas

measures to reduce unemployment gives rise to inflation. It is like a trap. It is considered that a full-employment situation is a country's inflation threshold.

The Philips Curve merges the demand-pull and cost-push inflation and eliminates the distinction between them. It is proclaimed that the society itself chooses the best possible combination of price-level and employment. The least desired combination between the two could thus be eliminated by the society. Thus the Phillips Curve shows the trade-off between level of unemployment and wage-price increase. It is assumed that wage rise percentage is slightly more than price rise percentage. It shows that greater the unemployment, the lesser is the price rise, and vice versa. On the other hand, more the wage rise less is the level of unemployment, and vice versa.Social costs of involuntary unemployment are quite obvious. It cannot be ignored. Inflation can ultimately be considered as a severe form of taxation on the economy as a whole


Effects of inflation on monetary policy.

Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability. The official goals usually include relatively stable prices and low unemployment. Monetary theory provides insight into how to craft optimal monetary policy. It is referred to as either being expansionary or contractionarys where an expansionary policy increases the total supply of money in the economy more rapidly than usual, and contractionarys policy expands the money supply more slowly than usual or even shrinks it. Expansionary policy is traditionally

used to try to combat unemployment in a recession by lowering interest rates in the hope that easy credit will entice businesses into expanding. Contractionarys policy is intended to slow inflation in hopes of avoiding the resulting distortions and deterioration of asset values. Monetary policy differs from fiscal policy, which refers to taxation, government spending, and associated borrowing.

Chapter: - 06 After completing this chapter you will come know about:-

 Monetary Measures  Fiscal measures  Other Non-monetary Measures

There are broadly two ways of controlling inflation in an economy Monetary measures and fiscal measures.  Monetary measures and  Fiscal measures

 Monetary Measures
The most important and commonly used method to control inflation is monetary policy of the Central Bank. Most central banks use high interest rates as the traditional way to fight or prevent inflation.

Monetary Measures Used To Control Inflation Include:(I) Bank Rate Policy (Ii) Cash Reserve Ratio And (Iii) Open Market Operations.

Bank rate policy is used as the main instrument of monetary control during the period of inflation. When the central bank raises the bank rate, it is said to have adopted a dear money policy. The increase in bank rate increases the cost of borrowing which reduces commercial banks borrowing from the central bank. Consequently, the flow of money from the commercial banks to the public gets reduced. Therefore, inflation is controlled to the extent it is caused by the bank credit.

Cash Reserve Ratio (CRR):- To control inflation, the central bank raises the CRR which reduces the lending capacity of the commercial banks. Consequently, flow of money from commercial banks to public decreases. In the process, it halts the rise in prices to the extent it is caused by banks credits to the public.

Open Market Operations:-Open market operations refer to sale and purchase of government securities and bonds by the central bank. To control inflation, central bank sells the government securities to the public through the banks. This results in transfer of a part of bank deposits to central bank account and reduces credit creation capacity of the commercial banks.

 Monetary measures to control inflation:Credit control Issue of new currency Demonetization of currency
The monetary measures to control inflation generally aims at reducing money incomes. These are: (a) Credit Control:- The central bank could adopt a number of methods to control the quantity and quality of credit to reduce the supply of money. For this purpose, it raises the bank rates, sells securities in the open market, raises reserve ratio, and adopts a number of selective credit control measures, such as raising margin requirements and regulating consumer credit. (b) Demonetization of Currency: -Another monetary measure is to demonetize currency of higher denominations. Such a measure is usually adopted when there is abundance of black money in the country. (c) Issue of New Currency: -The most extreme monetary measure is the issue of new currency in place of the old currency. Under this system, one new note is exchanged for a number of the old currency. Such a measure is adopted when there is an excessive issue of notes and there is

hyperinflation in the economy.

 Fiscal Measures
Fiscal measures to control inflation include taxation, government expenditure and public borrowings. The government can also take some protectionist measures (such as banning the export of essential items such as pulses, cereals and oils to support the domestic consumption, encourage imports by lowering duties on import items etc.)

Fiscal Measures includes the following:Monetary policy alone cannot control inflation. Therefore, it should be supplemented by fiscal measures. The principal fiscal measures are discussed below. (a) Reduction in Unnecessary Expenditure: The government should reduce unnecessary expenditure on non-development activities in order to curb inflation. (b) Increase in Taxes: To cut personal consumption expenditure, the rates of personal, corporate and commodity taxes should be raised and even new taxes should be levied, but the rates of taxes should not be too high as to discourage saving, investment and production. (c) Increase in Savings: Another measure is to increase savings on the part of the people so that their disposable income and purchasing power would be reduced. For this the government should encourage savings by giving various incentives. (d) Surplus Budgets: An important measure is to adopt anti-inflationary budgetary policy. For this purpose, the government should give up deficit financing and instead have surplus budgets. It means collecting more in revenues and spending less. (e) Public Debt: In addition, the government should stop repayment of public debt and postpone it to some future date till inflationary pressures are controlled. Instead, the government should borrow more to reduce money supply with the public.

 Other (Direct) Measures

Other measures to control inflation generally aims at increasing aggregate supply and reducing aggregate demand directly. These are :-

(a) To Increase Production.

The following measures should be adopted to increase production: The government should encourage the production of essential consumer goods like food, clothing, kerosene oil, sugar, vegetable oils, etc.  All possible help in the form of latest technology, raw materials, financial help, subsidies, etc. should be provided to different consumer goods sectors to increase production.

(b) Rational Wage Policy: Another important measure is to adopt a rational wage policy.
The best course for this is to link increase in wages to increase in productivity. This will have a dual effect. It will control wage and at the same time increase production of goods in the economy.

(c) Price Control: Price control and rationing is another measure of direct control to check
inflation. Price control means fixing an upper limit for the prices of essential consumer goods.

(d) Rationing: Rationing aims at distributing consumption of scarce goods so as to make them
available to a large number of consumers. It is applied to essential consumer goods such as wheat, rice, sugar, kerosene oil, etc. It is meant to stabilize the prices of necessaries and assure distributive justice.

Chapter: - 07 After completing this chapter you will come know about:     Reasons for inflation in India Inflation Pressure over the Last Few Months Inflation in India and other Developed Countries Inflation during 1980's and 1990's Global Inflation A Comparison With India

 REASONS FOR INFLATION IN INDIA

There are four main reasons. The immediate reason for the spurt in the prices of specific food items, like onions today or earlier in the case of sugar and pulses, is hoarding. Trader cartels, encouraged by an inept Government, are mainly responsible for this. Assured of inaction, hoarders are creating artificial shortages and fleecing people from time to time. Secondly, the growing penetration of big corporate in the food economy, international trade in food items and speculative futures trading in agricultural commodities has weakened the governments capacity to control food prices. The share of corporate retail in food distribution has tripled over the past four years. The Government has manipulated trade policies to allow big traders to make huge profits through export and import of essential food items like wheat, sugar and onions. On the other hand, the PDS has been weakened considerably through targeting. In most states, the role of the ration shops, state agencies like the NAFED etc. and consumer cooperatives in food distribution, has been whittled down. Therefore, the profit margins of private traders have also increased, reflected in growing gaps between wholesale and retail prices as well as farm gate and wholesale prices.

There are medium and long-term reasons too. Our agriculture is in a crisis. We are not producing enough to meet the needs of a growing population. The peasantry continues to be in distress, with 2.5 lakh farmers committing suicide over the past 15 years. State intervention in raising agricultural productivity has been weakened. The Government is more interested in handing over this role to big agribusinesses and retail giants like Walmart and Monsanto in the name of a second green revolution. That will further marginalize the small peasants. Finally, the cuts in subsidies and price hikes of inputs like diesel and fertilizer are also contributing to food inflation. The deregulation of petrol prices has led to very steep hikes in the recent weeks.

 Inflation Pressure over the Last Few Months

Retail Prices of Some Essential Commodities in Delhi: 2008 to 2011 (Rs./kg)
Retail Price Item Rice Wheat Atta Chana Dal Arhar Dal Moong Dal Masoor Dal Sugar Milk (Rs./litre) Groundnut Oil Mustard Oil Vanaspati Tea Loose 2011) 23 15.5 17 35 69 68 54 34 25 135 79 77 149 Retail Price 2010) 23 16 18 38 84 81 62 42.5 22 113 71 57 156 Retail Price 2009) 22 13 14 35 50 45 62 23 21 109 77 54 144 Retail Price 2008) 17 13 14 35 42 36 39 17 20 121 69 67 107

(end-January (end-January (end-January (end-January

Salt Pack (Iodized) Potato Onion

13 8 33

12 9 23

11 8 21

10 8 9

 Inflation in India and other Developed Countries

Inflation is spreading across the world's largest emerging nations, leaving a noisy rattle in what have been the engines of global growth in recent years. Central banks in Brazil, Russia, India and China, the fast-growing so-called BRIC nations now responsible for nearly a fifth of global economic activity, have all raised interest rates in recent weeks, and are testing more exotic measures to stanch rising prices, especially for food: India and Russia banned exports of onions and wheat, respectively, while China has promised price controls on items such as cooking oil. Brazil said Friday that its 2010 inflation rate had risen to 5.9%, its fastest rate in six years, raising the chances the nation will push its already sky-high interest rates even higher, potentially hampering growth. To be sure, Brazil's single-digit inflation rate is a universe away from the hyperinflation it suffered in the early 1990s. And some analysts say fears of an emerging-market inflation spiral are overstated, with current inflation rates still below where they were when prices peaked before the financial crisis in 2008.Still, the inflation trend is creating tricky policy headaches for officials from Beijing to New Delhi, including fears that rising food prices in these mostly poor nations may jeopardize social stability. "Inflation is one of the major risks for this year," says Nicholas Kwan, economist for Standard Chartered in Hong Kong. The accelerating price gains in the developing world contrast sharply with low inflation rates in Europe and the U.S. and persistent price declines in Japan. The divergence is partly a byproduct of the stronger economic recoveries achieved by emerging

nations compared with sluggish growth in the West.

Such diverging economic fortunes are complicating inflation-fighting efforts in the developing world, economists say. Leaders in Brazil and other countries complain that the U.S. Federal Reserve's decision to pump $600 billion into the economy promotes commodity inflation and asset bubbles by weakening the dollar. U.S. Federal Reserve Chairman Ben Bernanke said Friday the stimulus measure wasn't adding to inflation

 Inflation during 1980's and 1990's

The nation endured a deep recession throughout 1982. Business bankruptcies rose 50 percent over the previous year. Farmers were especially hard hit, as agricultural exports declined, crop prices fell, and interest rates rose. But while the medicine of a sharp slowdown was hard to swallow, it did break the destructive cycle in which the economy had been caught. By 1983, inflation had eased, the economy had rebounded, and the United began a sustained period of economic growth. The annual inflation rate remained under 5 percent throughout most of the 1980s and into the 1990s.  The Political Impact of the Poor Economy in the 1970s The economic upheaval of the 1970s had important political consequences. The American people expressed their discontent with federal policies by turning out Carter in 1980 and electing former Hollywood actor and California governor Ronald as president.  Reagan's Economic Policy Reagan (1981-1989) based his economic program on the theory of supply-side economics, which advocated reducing tax rates so people could keep more of what they earned. The theory was that lower tax rates would induce people to work harder and longer, and that this in turn would lead to more saving and investment, resulting in more production and stimulating overall economic growth. While the Reagan-inspired cuts served mainly to benefit wealthier Americans, the economic theory behind the cuts argued that benefits would extend to lower-income people as well because higher investment would lead new job opportunities and higher wages.  The Size of the Government The central theme of Reagan's national agenda, however, was his belief that the federal government had become too big and intrusive. In the early 1980s, while he was cutting taxes,

Reagan was also slashing social programs. Reagan also undertook a campaign throughout his tenure to reduce or eliminate government regulations affecting the consumer, the workplace, and the environment. At the same time, however, he feared that the United States had neglected its military in the wake of the Vietnam War, so he successfully pushed for big increases in defense spending. The combination of tax cuts and higher military spending overwhelmed more modest reductions in spending on domestic programs. As a result, the federal budget deficit swelled even beyond the levels it had reached during the recession of the early 1980s. From $74,000 million in 1980, the federal budget deficit rose to $221,000 million in 1986. It fell back to $150,000 million in 1987, but then started growing again. Some economists worried that heavy spending and borrowing by the federal government would re-ignite inflation, but the Federal Reserve remained vigilant about controlling price increases, moving quickly to raise interest rates any time it seemed a threat. Under chairman Paul Volcker and his successor, Alan Greenspan, the Federal Reserve retained the central role of economic traffic cop, eclipsing Congress and the president in guiding the nation's economy.

 Global Inflation A Comparison With India

Inflation is no stranger to the Indian economy. In fact, till the early nineties Indians were used to double-digit inflation and its attendant consequences. But, since the mid-nineties controlling inflation has become a priority for policy framers. Inflation today is caused more by global rather than by domestic factors. Naturally, as the Indian economy undergoes structural changes, the causes of domestic inflation too have undergone tectonic changes. Needless to emphasise causes of today's inflation are complicated. However, it is indeed intriguing that the policy response even to this day unfortunately has been fixated on the traditional anti-inflation instruments of the pre-liberalization era.      Global imbalance the cause for global liquidity The psychological dimension Higher international farm prices impact Indian farm prices Growth and forex flows Revaluation of the Indian Rupee

conclusion