<–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:-
- GDP Deflator
- Cost of Living Index
- Producer Price Index(PPI)
- Wholesale Price Index(WPI)
- Consumer Price Index(CPI)
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.
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Inflation
Inflation is a general increase in prices and fall in the purchasing value of money. When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation reflects a reduction in the purchasing power per unit of money â a loss of real value in the medium of exchange and unit of account within the economy.
Inflation is usually expressed as a percentage, such as 2% per month or 10% per year. A common measure of inflation is the consumer price index (CPI), which measures the prices of a basket of consumer goods and services.
There are two main types of inflation: demand-pull inflation and cost-push inflation. Demand-pull inflation occurs when Aggregate Demand in the economy increases faster than Aggregate Supply. This can happen when the government increases spending, lowers taxes, or expands the Money Supply. Cost-push inflation occurs when the costs of production increase, such as when wages or raw material prices rise. This can happen when there is a shortage of labor or Resources, or when there is a sudden increase in demand for goods and services.
Inflation can have a number of negative effects on the economy. It can erode the value of Savings, make it difficult for businesses to plan for the future, and lead to higher interest rates. Inflation can also lead to social unrest and political instability.
There are a number of ways to control inflation. Monetary policy is one way to control inflation. The central bank can use monetary policy to increase or decrease the money supply. When the money supply increases, inflation tends to increase. When the money supply decreases, inflation tends to decrease.
Fiscal Policy is another way to control inflation. The government can use fiscal policy to increase or decrease government spending. When government spending increases, inflation tends to increase. When government spending decreases, inflation tends to decrease.
The government can also use direct Measures to control Inflation. Direct measures include price controls, wage controls, and import controls. Price controls are laws that set maximum prices for goods and services. Wage controls are laws that set maximum wages for workers. Import controls are laws that restrict the importation of goods and services.
Monetary measures
Monetary policy is the use of money and credit controls to influence the economy. The central bank, which is the government’s bank, is responsible for implementing monetary policy.
The main Tools Of Monetary Policy are open market operations, the DISCOUNT rate, and reserve requirements.
Open market operations are the buying and selling of Government Bonds by the central bank. When the central bank buys government bonds, it injects money into the economy. When the central bank sells government bonds, it takes money out of the economy.
The discount rate is the interest rate that the central bank charges banks for loans. When the central bank lowers the discount rate, it makes it cheaper for banks to borrow money. This can lead to an increase in lending and an increase in the money supply.
Reserve requirements are the amount of money that banks are required to hold in reserve. When the central bank lowers reserve requirements, it allows banks to lend more money. This can lead to an increase in lending and an increase in the money supply.
Fiscal measures
Fiscal policy is the use of government spending and Taxation to influence the economy. The government uses fiscal policy to try to achieve economic goals such as full EMPLOYMENT, stable prices, and economic Growth.
The main tools of fiscal policy are government spending and taxation.
Government spending is the amount of money that the government spends on goods and services. When the government increases spending, it injects money into the economy. When the government decreases spending, it takes money out of the economy.
Taxation is the amount of money that the government collects from individuals and businesses. When the government increases taxes, it takes money out of the economy. When the government decreases taxes, it puts money into the economy.
Direct measures
Direct measures are government actions that are designed to control prices, wages, and imports.
Price controls are laws that set maximum prices for goods and services. Wage controls are laws that set maximum wages for workers. Import controls are laws that restrict the importation of goods and services.
Direct measures are often used in times of high inflation. They can be effective in controlling prices and wages in the short run, but they can also lead to shortages and black markets.
Inflation is a general increase in prices and fall in the purchasing value of money.
What are the causes of 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
- A decrease in the value of the currency
What are the effects of inflation?
Inflation can have a number of negative effects, including:
- A decrease in the purchasing power of money
- A decrease in the value of savings
- An increase in interest rates
- A decrease in Investment
- A decrease in economic growth
How can inflation be controlled?
There are a number of ways to control inflation, including:
- Monetary policy: The central bank can use monetary policy to control the money supply.
- Fiscal policy: The government can use fiscal policy to control demand.
- Direct measures: The government can use direct measures, such as price controls, to control inflation.
What are the benefits of controlling inflation?
There are a number of benefits to controlling inflation, including:
- A decrease in the cost of living
- An increase in the value of savings
- A decrease in interest rates
- An increase in investment
- An increase in economic growth
What are the costs of controlling inflation?
There are a number of costs to controlling inflation, including:
- A decrease in economic output
- An increase in Unemployment
- A decrease in investment
- A decrease in economic growth
What is the ideal rate of inflation?
There is no one-size-fits-all answer to this question, as the ideal rate of inflation will vary depending on the country and its economic circumstances. However, most economists agree that a low and stable rate of inflation is desirable.
What is hyperinflation?
Hyperinflation is a very high rate of inflation, typically defined as a monthly inflation rate of 50% or more. Hyperinflation can be caused by a number of factors, including:
- A loss of confidence in the currency
- A large budget deficit
- A war
What are the effects of hyperinflation?
Hyperinflation can have a number of negative effects, including:
- A decrease in the purchasing power of money
- A decrease in the value of savings
- An increase in interest rates
- A decrease in investment
- A decrease in economic growth
- A breakdown in the social order
How can hyperinflation be stopped?
There are a number of ways to stop hyperinflation, including:
- Austerity measures: The government can implement austerity measures to reduce the budget deficit.
- Monetary reform: The government can implement monetary reform to stabilize the currency.
- International assistance: The government can seek international assistance to stabilize the economy.
Inflation is a general increase in prices and fall in the purchasing value of money. When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation reflects a reduction in the purchasing power per unit of money â a loss of real value in the medium of exchange and unit of account within the economy.
Control of inflation is the process of managing the rate of inflation in an economy. There are three main types of measures that can be used to control inflation: monetary, fiscal, and direct measures.
Monetary measures involve the use of monetary policy to control the money supply. The central bank can increase or decrease the money supply by buying or selling government bonds. When the money supply increases, inflation tends to increase. When the money supply decreases, inflation tends to decrease.
Fiscal measures involve the use of fiscal policy to control the government’s budget deficit. When the government runs a budget deficit, it injects money into the economy. This can lead to inflation. When the government runs a budget surplus, it takes money out of the economy. This can help to reduce inflation.
Direct measures involve the use of government regulations to control prices and wages. For example, the government can set a maximum price for gasoline or a minimum wage for workers. These measures can help to control inflation, but they can also have negative side effects, such as shortages and unemployment.
Question 1
Which of the following is not a measure of inflation?
(A) The Consumer Price Index (CPI)
(B) The Producer Price Index (PPI)
(C) The GDP deflator
(D) The unemployment rate
Answer
(D) The unemployment rate is not a measure of inflation. It is a measure of the number of people who are unemployed.
Question 2
Which of the following is a monetary measure of inflation?
(A) The Consumer Price Index (CPI)
(B) The Producer Price Index (PPI)
(C) The GDP deflator
(D) The money supply
Answer
(D) The money supply is a monetary measure of inflation. It is the total amount of money in circulation in an economy.
Question 3
Which of the following is a fiscal measure of inflation?
(A) The Consumer Price Index (CPI)
(B) The Producer Price Index (PPI)
(C) The GDP deflator
(D) The government budget deficit
Answer
(D) The government budget deficit is a fiscal measure of inflation. It is the amount of money that the government spends more than it takes in through taxes.
Question 4
Which of the following is a direct measure of inflation?
(A) The Consumer Price Index (CPI)
(B) The Producer Price Index (PPI)
(C) The GDP deflator
(D) Price controls
Answer
(D) Price controls are a direct measure of inflation. They are government regulations that set maximum or minimum prices for goods and services.
Question 5
Which of the following is the most effective way to control inflation?
(A) Monetary measures
(B) Fiscal measures
(C) Direct measures
(D) A combination of monetary, fiscal, and direct measures
Answer
(D) The most effective way to control inflation is to use a combination of monetary, fiscal, and direct measures.