New Delhi Institute Of Management Presentation By Group V Batch 13 (a) Mohammad Salman Ali Balister Rajeev Vasudevan Rakesh Aggarwal

New Delhi Institute Of Management Presentation by Group V Batch 13 (A) Mohammad Salman Ali Balister Rajeev Vasudevan Rakesh Aggarwal

Index Introduction Types of Inflation Calculation Causes Effects of Inflation Inflation and India (Impact on India) Measures to Control Inflation

Inflation

Gross Domestic Product

Introduction

Inflation • Inflation can be defined as the general tendency for

prices to rise and a decline in the purchasing power of money. • Inflation needs to be examined in REAL terms to

understand its actual impact upon the economy • Example: If wages rise by 5% and inflation stands at

6% then in real terms wages have fallen by 1%.

Inflation Rate: The Inflation rate is the percentage by which prices of goods and services rise beyond their average levels. It is the rate by which the purchasing power of the people in a particular geography has declined in a specified period. The rate of inflation may be calculated weekly, monthly or annually. However, it is always expressed as an annualized figure.

Deflation Deflation (for example, -1%) occurs when prices actually decrease over a period of time. Please note that deflation is not the same as disinflation, which is when the rate of inflation decreases but stays positive (for example, a change from a 3% rate to a 2% rate).

Stagflation – is used when there is stagnation as well as inflation.

The economic cycle and the MPC’s role GDP

Inflation rising

GDP Growth trend

Unemployment worries/inflation falling Time

Types of Inflation Moderate Inflation Running Inflation Galloping Inflation Hyper Inflation

1. Moderate Inflation It occurs when prices are rising slowly & when

the rate of inflation is less than 10 per cent annually or it is a single digit inflation rate When the price is moderate & is in the range

up to 2% it is called creeping inflation. And when it is in the range of 4 to 5% it is called as walking inflation.

2.Running Inflation  When prices rise by more than 10 per cent a

year, running inflation occurs. But, we may say that a double digit inflation

of 10-20 per cent per annum is a running inflation.

3. Galloping Inflation  According to Samuelson, when prices are

rising at double or triple digit rates of 20, 100 or 200 per cent a year, the situation is described as ‘galloping’ inflation. Galloping inflation is really a serious problem.

It causes economic disturbances.

4. Hyper Inflation In hyperinflation prices rise every movement,

and there is no limit to the height to which prices might rise. In quantitative terms, when prices rise over 1000 per cent in a year, it is called a hyperinflation. In Germany, hyperinflation hit during the

1920s.

Here’s a German woman stuffing her fireplace with worthless paper money in 1923.

CALCULATION OF INFLATION Wholesale Price Index (WPI) WPI was first published in 1902, and was one of the more economic indicators available to policy makers until it was replaced by most developed countries by the Consumer Price Index in the 1970s. WPI is the index that is used to measure the change in the average price level of goods traded in wholesale market. In India, a total of 435 commodities data on price level is tracked through WPI which is an indicator of movement in prices of commodities in all trade and transactions. It is also the price index which is available on a weekly basis with the shortest possible time lag only two weeks. The Indian government has taken WPI as an indicator of the rate of inflation in the economy.

How is it calculated? If P0 is the current average price level and P −1 is the price level a year ago, the rate of inflation during the year might be measured as follows:

After the year the purchasing power of a unit of money is multiplied by a factor 1 / ( 1 + inflation rate ). There are other ways of defining the inflation rate, such as logP0 − logP −1 (using the natural log), again stated as a percentage. In this case after the year the purchasing power of a unit of money is multiplied by a factor e −inflationrate .

There are two general methods for calculating inflation rates - one is to use a base period, the other is to use "chained" measurements. Chained measurements adjust not only the prices, but the contents of the market basket involved, with each price period. More common, however, is the base period reference. This can be seen from inflation reports from the "relative weight" assigned to each component, and by looking at the technical notes to see what each item in an inflation basket represents and how it is calculated.

Consumer Price Index (CPI) CPI is a statistical time-series measure of a weighted average of prices of a specified set of goods and services purchased by consumers. It is a price index that tracks the prices of a specified basket of consumer goods and services, providing a measure of inflation. CPI is a fixed quantity price index and considered by some a cost of living index. Under CPI, an index is scaled so that it is equal to 100 at a chosen point in time, so that all other values of the index are a percentage relative to this one.

World have changed form WPI to CPI as an indicator of Inflation India is the only major country that uses a wholesale index to measure inflation. Most countries use the CPI as a measure of inflation, as this actually measures the increase in price that a consumer will ultimately have to pay for. CPI is official barometer of Inflation in: USA, UK, Japan, France, Canada, Singapore, China.

Why is India not switching over to the CPI method of calculating inflation? Finance ministry officials point out that there are many intricate problems from shifting from WPI to CPI model. Reluctant to change. In India, there are four different types of CPI indices, and that makes switching over to the Index from WPI fairly 'risky and unwieldy.' The four CPI series are: CPI Industrial Workers; CPI Urban Non-Manual Employees; CPI Agricultural labourers; and CPI Rural labour. officials say the CPI cannot be used in India because there is too much of a lag in reporting CPI numbers. In fact, as of May 21, the latest CPI number reported is for March 2006. WPI is published on a weekly basis and the CPI, on a monthly basis.

Causes of Inflation DEMAND PULL INFLATION COST - PUSH INFLATION

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DEMAND PULL INFLATION Demand pull inflation occurs when aggregate

demand exceeds the aggregate supply Demand pull inflation is commonly referred to too much money chasing after too few goods and services Rise in aggregate demand which may due to a rise in consumer demand or level of government expenditure or investment by firm or country’s exports or a combination of the four

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General price level AS

P2

P1 AD2

P0 Increase in AD full An increase in above AD0 towards Yf employment (AD1 to increase AD2) increase (AD1 to AD2) show in price to P2level (P0 to P1) the price

AD1

AD0

0 10/16/09

Real output has reached the maximum limit but prices are still increasing

Yf

Real output 23

COST–PUSH INFLATION Cost-push inflation refers to an increase in the

general price level associated with an increase in the cost of production Cost-push inflation basically means that prices have been “pushed up” by increases in costs of some of the factors of production such as labor, capital etc.

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Effects of Inflation Inflation can have negative and positive effects on an economy. Negative Effects: Negative effects of inflation include: loss in stability in the real value of money and other monetary items over time; uncertainty about future inflation may discourage investment and saving, and high inflation may lead to shortages of goods if consumers begin hoarding out of concern that prices will increase in the future. Positive Effects: Positive effects include a mitigation of economic recessions, and debt relief by reducing the real level of debt.

NEGATIVE EFFECTS 1. Purchasing power Inversely related to price –price, dollar buys less –(deflation, dollar buys more) An increase in the general level of prices implies a decrease in the purchasing power of the currency. That is, when the general level of prices rises, each monetary unit buys fewer goods and services 2. Cost-push inflation Rising inflation can prompt employees to demand higher wages, to keep up with consumer prices. Rising wages in turn can help fuel inflation. In the case of collective bargaining, wages will be set as a factor of price expectations, which will be higher when inflation has an upward trend. This can

3.   

Interest rates rise in response to inflation Discourages some borrowing and spending High inflation rates devalue savings Savings lose value if interest rate is less than the inflation rate

4. Market Inefficiency  High or unpredictable inflation rates they add inefficiencies in the market, and make it difficult for companies to budget or plan long-term.  Inflation can act as a drag on productivity as companies are forced to shift resources away from products and services in order to focus on profit and losses from currency inflation

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A change in the supply or demand for a good will normally cause its price to change, signaling to buyers and sellers that they should re-allocate resources in response to the new market conditions. Investors are scared to invest for long-term purposes hence the short-term investments increase.

Positive Effects 1.   

Labor-market adjustments This can lead to prolonged disequilibrium and high unemployment in the labor market. Inflation would lower the real wage if nominal wages are kept constant. As it would allow labor markets to reach equilibrium faster.

2. Debt Relief  Debtors who have debts with a fixed nominal rate of interest will see a reduction in the "real" interest rate as the inflation rate rises.

• Banks and other lenders adjust for this inflation risk either by including an inflation premium in the costs of lending the money by creating a higher initial stated interest rate or by setting the interest at a variable rate. 3. Room to maneuver The primary tools for controlling the money supply are the ability to set the discount rate, the rate at which banks can borrow from the central bank. open market operations which are the central bank's interventions into the bonds market with the aim of affecting the nominal interest rate.

Inflation & India Impact of Inflation in India

0% Dec-05

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Wholesale Price Inflation

12%

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8%

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4%

2%

Inflation & India Indian inflation is measured by Wholesale

Price Index (WPI) is released every week. Past One month this number came out negative for the first time in 32 years. Although WPI is indicating deflation, no one in India is concerned about it and this negative number is attributed to high base index.

The Economic Effects of Inflation Inflation & Distribution of Income The effect of inflation on income distribution depends on how it affects the prices received and price paid. (Price received can be called as income whereas price paid is called as expenditure). Inflation changes income & distribution pattern only when it creates divergence between total price received and paid.

Effect of Inflation on Distribution of Wealth Asset

Price Variable Assets

Fixed Claim Assets (Bonds, Loans & Term Deposit)

Physical Assets

Financial Assets

(Building, Land)

(Share & Stocks)

The effects of Inflation on Distribution of wealth depend on how inflation affects the net worth (Assets – Liabilities)

Effect of inflation on Different sections of society Wage Earners: Wage earners in general are losers during period of inflation. The wage earners are labour so it is divided into organized and unorganized sector. Organized labour Market gets the compensation through union but unorganized labour Market doesn’t get the increment in wages as compared with organized sector at time of inflation.

Effect of inflation on Different sections of society Cont…. Producers: Producers lose or gain depends on price they

pay and receives during the period of inflation. The product price rises due to demand pull factors & rise in money supply but the input price remain the same and because of this profit margin increases. The producers gain during inflation due to wage-lag & input increases at lower rate.

Effect of inflation on Different sections of society Cont…. Fixed Income Class:  Fixed income class groups are the losers during the

time of inflation.  The reason is income is fixed but the prices of goods, commodities & services increases. Borrower & Lenders  In this case Borrower gains and lender losses.  For example a borrower take a home loan at percent say 12% on Rs. 5,00,000/- for five years at simple interest . After 5 yrs the rate of property gets double. So after five yrs borrower will pay Rs. 8,00,000/- but the value of his property is Rs. 10,00,000/-.

Effect of inflation on Different sections of society Cont….

The Government: Government is the net gainer during period of inflation. Government collects tax inform of direct (Personal & corporate Taxes) and indirect tax (Custom Tax, Excise Tax & Sales Tax). 

Direct Tax:  Inflation increases the nominal income at the rate of inflation, real income remaining the same.  As a consequence an income which was non-taxable prior to inflation becomes taxable after inflation.  This lead to tax revenue. Because of this income taxable at course becomes taxable at higher rate

Effect of inflation on Different sections of society Cont…. 

Indirect Tax:  Indirect tax contributes major part of income for government.  As prices are higher at time of inflation the revenue generated is high.  So, we can make out that government is net borrower and enjoys net gain during period of inflation.

Effects of Inflation on Economic Growth Theoretical Level

Empirical Level (Practical Level)

The rate of Economic

Until the 1970 high

growth depends primary on the rate of capital formation which depends on rate of saving & Investment. Lower rate of income increases investment.

inflation usually took a hand to hand with high employment & Output. At time of inflation investment are high & job are plentiful. Output & inflation have temporary positive relationship.

Effects of Inflation on Employment Inflation when allowed to grow

INFLATION EMPLOYMENT ECONOMIC GROWTH

Effects of Inflation on Employment Inflation when not allowed to grow

INFLATION EMPLOYMENT ECONOMIC GROWTH

Effects of Inflation on Common People Goods Once Essential, now luxurious

Real Market Scenario

A). Monetary measures: Monetary measures relate to the control in the supply

and circulation of money in the country. 1. Bank

rate : In case of inflation, the bank rate is increased; the supply of money is controlled. 2.

Open market operation: During inflation, the central bank sells govt. securities and price bonds in the open market in order to contract the supply of money. 3. Variable reserve ratio: In order to control inflation, the central bank increases the reservation. 4. Credit Rationing: When there is inflationary pressure, the State bank adopts the policy of credit rationing.

5. CRR (Cash Reserve Ratio): Cash Reserve ratio is amount of cash that a Bank has to kept with RBI. 6. SLR (Statutory Liquid Ration): SLR is a percent of cash which a Bank has to kept with themselves as a reserve.

B). Fiscal Measures: Measures in connection with public borrowing public expenditures and public revenues are called fiscal measures. 1. Public Borrowing: During inflation, increase the public borrowing, during deflation, decrease in public borrowing.

2. Public Revenues: In order to control inflation, the increase in public revenues by the Govt. 3. Public expenditures: Inflation is also controlled by decreasing the public expenditures by the Govt.

(C). Realistic Measures: 1. Increase the supply of goods and services: When the supply of goods and services is increased, the prices will come down. 2. Population planning: Control on population by adopting different measures of family planning will reduce the demand and finally prices will be controlled. 3. Price control policy: The govt. should adopt strict price control policy against the profiteers and hoarders. 4. Economic Planning: Effective economic planning is necessary to control the inflation in the country.

The central banks, monetary authorities or finance ministries of most nations have the authority to take economic measures to control rising inflation by regulating the following factors: 

Reducing the central bank interest rates and increasing bank interest rates.

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Regulating fixed exchange rates of the domestic currency.

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Controlling prices and wages.

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Providing cost of living allowance to citizens in order to create demand in the market.

Inflation cannot be controlled by taking a single measure. However, if monetary and fiscal measures are wisely coordinated, it can greatly help in controlling the continuous process of rising prices. The main anti inflationary measures both short and long terms are: Containing money supply; the monetary supply should be kept within reasonable limits.  Reducing budgetary deficit : the budgetary deficit should be kept low level. The deficit should be met by disciplined policy of demand management. Emphasis on commodity producing sectors:The government should give special attention to the production of cottons, wheat, vegetable , edible oil etc. it will have soothing effects on inflating.

Commodity balance:

The government should have a strict watch on the prices of essential commodities in the country. It should take immediate steps in changing the import and export duties and maintain the availability of goods is reasonable prices.

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