Inflation and oil prices

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<–2/”>a >Inflation & Control Mechanism

Inflation is a sustained increase in the general price level of goods and Services in an economy over a period of time. When the price level rises, each unit of currency buys fewer goods and services.It is the Percentage change in the value of the Wholesale Price Index (WPI) on a year-on year basis. It effectively measures the change in the prices of a basket of goods and services in a year. In India, inflation is calculated by taking the WPI as base.

 Formula for calculating Inflation=

(WPI in month of current year-WPI in same month of previous year)
————————————————————————————– X 100
WPI in same month of previous year

Inflation occurs due to an imbalance between demand and Money/”>Supply of Money, changes in production and distribution cost or increase in taxes on products. When economy experiences inflation, i.e. when the price level of goods and services rises, the value of currency reduces. This means now each unit of currency buys fewer goods and services.

It has its worst impact on consumers. High prices of day-to-day goods make it difficult for consumers to afford even the basic commodities in life. This leaves them with no choice but to ask for higher incomes. Hence the government tries to keep inflation under control.

Contrary to its negative effects, a moderate level of inflation characterizes a good economy. An inflation rate of 2 or 3% is beneficial for an economy as it encourages people to buy more and borrow more, because during times of lower inflation, the level of interest rate also remains low. Hence the government as well as the central bank always strive to achieve a limited level of inflation.

Various measures of Inflation are:-

There are following types on Inflation based on their causes:-

  • Demand pull inflation
  • cost push inflation
  • structural inflation
  • speculation
  • cartelization
  • hoarding

Various control measures to curb rising inflation are:-

  • Fiscal measures like reduction in indirect taxes
  • Dual pricing
  • Monetary measures
  • Supply side measures like importing the shortage goods to meet the demand
  • Administrative measures to curb hoarding, Cratelization.

Monetary Measures to curb rising inflation
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 :-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.
(ii) Cash Reserve Ratio :-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.
(iii) 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 result in transfer of a part of bank deposits to central bank account and reduces credit creation capacity of the commercial banks.

Fiscal Measures to curb rising inflation

The government may raise both direct and indi­rect taxes to wipe out excess aggregate spend­ing. Once a tax on income and/or wealth is imposed, disposable income gets reduced. This will greatly reduce private aggregate spending.

Direct control on prices and rationing of scarce goods are the two such regulatory measures.

1. Direct Controls on Prices:

The purpose of price control is to fix an upper limit beyond which the price of particular commodity is not allowed and to that extent inflation is suppressed.

2. Rationing:

When the government fixes the quota of certain goods so that each person gets only a limited quantity of the goods, it is called rationing. Rationing becomes necessary when the essential consumer goods are relatively scarce.

The purpose of rationing is to divert consumption from those goods whose supply needs to be restricted for some special reason, e.g., to make such commodities available to a large number of people.

Brent Crude is a major trading Classification of sweet Light crude oil that serves as a major benchmark price for purchases of oil worldwide. This grade is described as light because of its relatively low density, and sweet because of its low sulphur content. Brent Crude is extracted from the North Sea and comprises Brent Blend, Forties Blend, Oseberg and Ekofisk crudes (also known as the BFOE Quotation). The Brent Crude oil marker is also known as Brent Blend, London Brent and Brent petroleum.

 

Effect of oil prices :

  1. Will adversely affect the twin deficit and current deficit of the economy which will have spillover impact.
  2. Oil prices are highly vulnerable due to the geopolitical factors and hence they affect our monetary and fiscal policies.
  3. Rampant change in oil prices affect our economy by bringing inflation in our economy and hence Growth.

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Inflation

Inflation is a general increase in prices and fall in the purchasing value of money. It is usually expressed as a percentage, such as 2% inflation per year. Inflation can be caused by a number of factors, including:

  • Demand-pull inflation: This occurs when there is an increase in Aggregate Demand, which can be caused by factors such as an increase in government spending, a decrease in taxes, or an increase in the Money Supply.
  • Cost-push inflation: This occurs when there is an increase in the costs of production, which can be caused by factors such as an increase in the prices of raw materials, an increase in wages, or an increase in taxes.
  • Built-in inflation: This occurs when workers and businesses expect inflation to continue, and therefore demand higher wages and prices, which in turn leads to even higher inflation.

Inflation can have a number of negative effects on the economy, including:

  • It can erode the value of Savings: When prices are rising, the value of money falls. This means that people who have saved money will see its value decline over time.
  • It can make it difficult for businesses to plan: When prices are rising, it is difficult for businesses to know what their costs will be in the future. This can make it difficult for them to make Investment decisions.
  • It can lead to social unrest: When people see their incomes not keeping up with the rising cost of living, they may become frustrated and angry. This can lead to social unrest and political instability.

There are a number of things that governments can do to try to control inflation, including:

  • Monetary policy: The central bank can use monetary policy to control the money supply. By raising interest rates, the central bank can make it more expensive to borrow money, which will help to reduce demand and therefore inflation.
  • Fiscal Policy: The government can use fiscal policy to control inflation by raising taxes or cutting spending. This will help to reduce aggregate demand and therefore inflation.
  • Incomes policy: The government can use incomes policy to control inflation by setting limits on wage increases. This will help to reduce cost-push inflation.

Oil prices

Oil prices are determined by a number of factors, including:

  • Demand for oil: The demand for oil is determined by a number of factors, including the global economy, the weather, and the price of oil itself.
  • Supply of oil: The supply of oil is determined by a number of factors, including the number of oil-producing countries, the cost of production, and political stability.
  • Geopolitical factors: Geopolitical factors, such as wars and civil unrest, can also affect the supply of oil and therefore oil prices.
  • Speculative factors: Speculators can also affect oil prices by buying or selling oil futures contracts.

Oil price shocks can have a number of negative effects on the global economy, including:

  • They can lead to recessions: When oil prices rise, it can lead to higher inflation, which can make it difficult for businesses to plan and invest. This can lead to a Recession.
  • They can increase POVERTY: When oil prices rise, it can lead to higher food prices, which can make it difficult for people to afford food. This can increase poverty.
  • They can lead to social unrest: When people see their incomes not keeping up with the rising cost of living, they may become frustrated and angry. This can lead to social unrest and political instability.

There are a number of things that governments can do to try to mitigate the effects of oil price shocks, including:

  • Diversification of energy sources: Governments can diversify their energy sources by investing in RENEWABLE ENERGY sources, such as solar and wind power. This will help to reduce the reliance on oil and therefore the impact of oil price shocks.
  • Energy Efficiency: Governments can promote energy efficiency by encouraging businesses and consumers to use less energy. This will help to reduce the demand for oil and therefore the impact of oil price shocks.
  • International cooperation: Governments can cooperate with each other to develop policies to mitigate the effects of oil price shocks. This could include things like setting up a global oil reserve or providing financial assistance to countries that are affected by oil price shocks.

What is Inflation?

Inflation is a general increase in prices and fall in the purchasing value of money.

What causes inflation?

Inflation can be caused by a number of factors, including:

  • An increase in the money supply
  • An increase in demand
  • A decrease in supply
  • A decrease in productivity

What are the effects of inflation?

Inflation can have a number of effects on an economy, including:

  • It can make it more difficult for businesses to plan and invest.
  • It can make it more difficult for people to save money.
  • It can lead to a decrease in the value of assets, such as property and stocks.
  • It can lead to social unrest.

What are the different types of inflation?

There are two main types of inflation:

  • Demand-pull inflation: This type of inflation occurs when there is an increase in aggregate demand, which is the total demand for goods and services in an economy. This can happen when the government increases spending, the central bank lowers interest rates, or there is an increase in exports.
  • Cost-push inflation: This type of inflation occurs when there is an increase in the costs of production, which can be caused by an increase in wages, raw materials, or energy prices.

What is the relationship between inflation and interest rates?

The relationship between inflation and interest rates is complex. In general, higher inflation leads to higher interest rates, as lenders demand a higher return on their investments to compensate for the loss of purchasing power. However, there are other factors that can also affect interest rates, such as the level of economic growth and the Unemployment rate.

What is the relationship between inflation and unemployment?

The relationship between inflation and unemployment is also complex. In general, there is an inverse relationship between inflation and unemployment, meaning that when inflation is high, unemployment is low, and vice versa. This is because when inflation is high, businesses are more likely to hire workers to meet the increased demand for goods and services. However, there are other factors that can also affect unemployment, such as the level of economic growth and the minimum wage.

What is the relationship between inflation and the stock market?

The relationship between inflation and the stock market is also complex. In general, stocks tend to do well when inflation is low and stable. This is because investors are more willing to invest in stocks when they believe that the value of their investment will not be eroded by inflation. However, there are other factors that can also affect the stock market, such as the level of economic growth and corporate earnings.

What is the relationship between inflation and exchange rates?

The relationship between inflation and exchange rates is also complex. In general, a country’s currency will tend to depreciate (lose value) when inflation is high. This is because investors are less willing to hold a currency that is losing value. However, there are other factors that can also affect exchange rates, such as the level of interest rates and the country’s trade balance.

Question 1

Which of the following is not a factor that affects inflation?

(A) The money supply
(B) The price of oil
(C) The unemployment rate
(D) The productivity of workers

Answer

(B) The price of oil is not a factor that affects inflation. Inflation is a measure of the rate at which prices for goods and services are rising in an economy. It is usually expressed as a percentage, and it can be caused by a number of factors, including the money supply, the price of oil, the unemployment rate, and the productivity of workers. However, the price of oil is not a direct factor that affects inflation. This is because the price of oil is only one of many factors that contribute to the overall cost of goods and services. For example, if the price of oil goes up, but the cost of other goods and services remains the same, then inflation will not necessarily go up. However, if the price of oil goes up and the cost of other goods and services also goes up, then inflation will likely go up.

Question 2

Which of the following is a negative effect of inflation?

(A) It can make it difficult for people to save money.
(B) It can make it difficult for businesses to plan for the future.
(C) It can lead to social unrest.
(D) All of the above

Answer

(D) All of the above are negative effects of inflation. Inflation can make it difficult for people to save money because the value of their savings will decrease over time. This is because the prices of goods and services will go up, so the same amount of money will not be able to buy as much as it used to. Inflation can also make it difficult for businesses to plan for the future because they will not know how much their costs will be in the future. This can make it difficult for them to make decisions about things like pricing and investment. Inflation can also lead to social unrest because people may become angry about the rising cost of living. This can lead to protests and other forms of social unrest.

Question 3

Which of the following is a positive effect of inflation?

(A) It can make it easier for businesses to borrow money.
(B) It can make it easier for people to get a raise.
(C) It can make it easier for people to pay off their debts.
(D) All of the above

Answer

(A) Inflation can make it easier for businesses to borrow money because the interest rates on loans will be lower. This is because the value of money is decreasing, so the amount of money that businesses have to pay back in the future will be worth less. Inflation can also make it easier for people to get a raise because their wages will increase along with the prices of goods and services. This means that their purchasing power will remain the same. Inflation can also make it easier for people to pay off their debts because the value of their debts will decrease over time. This is because the amount of money that they owe will be worth less in the future.

Question 4

Which of the following is the best way to control inflation?

(A) The government can raise interest rates.
(B) The government can reduce the money supply.
(C) The government can increase taxes.
(D) All of the above

Answer

(D) All of the above are ways that the government can control inflation. Raising interest rates makes it more expensive to borrow money, which can help to reduce demand and therefore prices. Reducing the money supply makes it more difficult for businesses and consumers to borrow money, which can also help to reduce demand and therefore prices. Increasing taxes can also help to reduce demand, as people will have less money to spend.

Question 5

Which of the following is the best way to protect yourself from inflation?

(A) Invest in assets that are not affected by inflation, such as gold or real estate.
(B) Keep your money in a savings account that pays a high interest rate.
(C) Invest in Inflation-Indexed Bonds.
(D) All of the above

Answer

(D) All of the above are ways to protect yourself from inflation. Investing in assets that are not affected by inflation, such as gold or real estate, will help to preserve your purchasing power. Keeping your money in a savings account that pays a high interest rate will help you to earn more money on your savings, which will help to offset the effects of inflation. Investing in inflation-indexed bonds is a way to protect your investment from the effects of inflation.