INFLATION & ITS MEASUREMENT
CURRENCY
- Rupee was first minted in India during the reign of Sher Shah Suri around 1542.
- India became a member of International Monetary Fund (IMF) in 1947, and exchange value of rupee came to be fixed by IMF standards.
- All coins and one rupee note are issued by government of India. That's why one rupee note doesn't bear the signature of governor of RBI. It bears the signature of Finance Secretary Government of India.
- It refers to the withdrawal of currency from circulation which is done to ambush black market.
Refers to reducing value of the lndian rupee in comparison to the leading currencies in the world market.
(i) First Devaluation → In June 1949 (by 30.5%) (finance minister: Dr. John Mathai)(ii) Second Devaluation → In June 1966 (by 57%) (finance minister: Sachindra Chaudhury)
(ii) Third Devaluation → On July 1, 1991 (by 9%) (finance minister: Dr. Manmohan Singh)
(iv) Fourth Devaluation → On July 3, 1991 (by 11%) Finance Minister: Dr. Manmohan Singh)
The basic objective of devaluation is to reduce deficits in balance of trade by making exports relatively cheap and imports costly.
INFLATION
The word 'Inflation' is often heard and seen in media. It is an important problem for policy makers, politicians and common people. Inflation assumes such an importance due to its all-round implications. in contrary deflation is less heard because this is a rare phenomenon. So, inflation deserves elaboration. Before getting into the subject matter of inflation it is better to look into index numbers and price indices first.
Types of Inflation
Different Inflations Based on Rate of Rise in Prices
1. Creeping Inflation
Price rise at very slow rate (less than 3%) like that of a snail or creeper is called Creeping inflation. is regarded safe and essential for economic growth.
2. Waling or Trotting Inflation
Price rise moderately at the rate of 3 to 7% (or) less than 10% is called Walking or trotting inflation. It is a warning signal to the government to be prepared to control inflation. If the inflation crosses this range, it will have serious implication on the economy and individuals.
3. Running Inflation
Running intlation means price rise rapidly like the running of a horse at a rate of 10-20%. It affects the economy adversely
4. Hyperinflation (or) Runaway (or) Galloping Inflation
The price rise at very fast at double- or triple-digit rate from 20 to 100% or more is called Hyperinflation (or) Runaway (or) galloping inflation. Such a situation brings total collapse of the monetary system because of the continuous fall in the purchasing power of money.
Different Inflations Based on Causes
1. Demand Pull Inflation
Demand pull inflation arises due to higher demand for goods and services over the available supply. Higher demand for g0ods and services arises due to increase in income of the people increase in money supply and change in the taste and preference of people etc. In other words, demand pull inflation takes place when increase in production lags behind the increase in money supply.
2. Cost Push Inflation
Like raw material, wages, profit margin etc., is called Cost push inflation. Both demands pull inflation and cost push inflation are affected by forces of demand and supply. They are discussed below.
EFFECTS OF INFLATION
Inflation has impact on all the economic units. It has favorable impact on some and unfavorable impact on others. The effects are discussed under three different heads as under:
1. Redistribution of income and wealthIt redistributes income from one hand to another. It leads to loss to some group of people and gain to another group of people.
a. Debtors Vs Creditors
In case of debtor and creditor, debtor is gainer and creditor are loser. Take an example. The debtor borrowed Rs. 100 for interest at the rate of 5% a day and debtor are a mango vendor. He has to repay Rs. 105 on the next day. The price of mango on day one is Rs. 10per mango. The debtor can buy 10 mangoes. On day two, the price of mango is Rs. 15. The debtor can sell 10 mangoes for Rs. 150. The debtor can repay his debt by selling only 7 mangoes. So, he gains Rs. 45 or 3 mangoes. The creditor can buy only 7 mangoes with Rs. 105 he got back. Suppose he purchased mango on day one instead of lending, he may have bought 10 mangoes. So, he loses 3 mangoes. This relation holds true for private as well as public debt.
b. Producers Vs Consumers
In inflationary situation, the producers stand to gain, and consumers stand to lose. The producer's stand to gain and consumers stand to lose. The producer's profit will increase as a result of inflation. The purchasing power of money held by consumer falls. So, they have to pay more money to purchase the same amount of goods and serves what they bought before inflation. Here, the income of consumer gets transferred from consumers to producers.
c. Flexible income group Vs Fixed income groupThe flexible income groups like sellers, self-employed, and employees of private concerns whose salary is adjusted according to inflation do not get affected, but fixed income groups like daily wage earners lose as the purchasing power of their income diminishes.
d. Debentures or Bond holders and Savers Vs Equity holders
The Debentures or Bond holders and Savers receive fixed periodical income from their financial assets. The purchasing power of their asset remain intact only if interest rate is more than rate of inflation. Take an example where the interest rate is 8%. The investor can earn Rs.8 for Rs 10 investment. Suppose if the rate of inflation is 10%, she/ he can buy fewer goods than that of her/ his purchase before inflation with the invested amount.
MEASURES TO CONTROL INFLATION
The control of inflation needs a multipronged strategy. All the strategies need cooperation and harmony among them.
1. Monetary Measures
a. Credit Control
Credit control method is used by RBI to control inflation. It is discussed in detail in the chapter 5 named Indian Financial System- Money Market. RBl used wholesale Price Index based inflation as a benchmark to control inflation. But now based on Urjit Patel Committee recommendation, RBI shifted targeting to newly introduced CPI (Combined). The reason is that the CPI (combined) measures the inflation in the consumer market. SO, it reflects the true and correct cost of living compared to WPL. The people expectation about future inflation is also based on price level in the consumer market.
b. Demonetization of Currency
Demonetization of currency means declaring that hereafter currencies of particular denominations are invalid. It suddenly reduces the money to the extent of money kept in those particular denominations. It is resorted to only in extreme cases.
c. lssue of New Currency
In this case all the money in circulation is withdrawn by government and new currency is issued. The new currency of single unit will be made equal to many units of old currency. For example, new currency of one Rupee will be made equal to Rs. 100 of old currency. So, the money supply is reduced to 1/100th, This too is resorted only under extreme cases.
2. Fiscal Measures
a. Reduction in unnecessary Expenditure
Reduction of unnecessary government expenditure means less demand from government side. it brings down the price level.
b. Increase in Direct Taxes
Increase in direct taxes like income tax reduces the disposable income available with people. it means low demand from households. Less demand leads to lower price.
c. Decrease in Indirect Taxes
Decrease in indirect taxes like excise duty, sales tax brings the prices down.
d. Surplus Budget
Surplus budget means less expenditure than receipts. It reduces the money supply and government demand for goods and services. The price level is brought down due to this.
3. Trade measures
Trade measures refer to export and import of goods and services. In case of shortage of goods in domestic market, the supply can be increased through import of goods from foreign countries at low or nil import duty. The restriction in the form of import licenses has to be eased to increase import. The higher Supply helps to bring down the price.
4. Administrative Measures
a. Rational Wage Policy
Rational wage policy helps to keep the cost of production under control. The cost control means price control.
b. Price Control
Direct price control also helps in inflation control. Price can be controlled by fixing maximum price limits through administered price system and subsidy from the government.
c. Rationing
Rationing of goods in short supply keeps the demand under control so that price comes under control.
DEFLATION
Deflation is opposite to that of inflation. The persistent and appreciable fall in the general level of prices is called as deflation. The rate of change of price index is negative. The effects, causes and measures are also in the opposite direction.
