Inflation & the Indian Economy
India has witnessed the annual inflation rate edged down to 7.04 per cent in May of 2022 from an 8-year high of 7.79 per cent in the month of April. The word inflation refers to a continuous rise in the general price level of goods and services in a given economy over a given period. The inflation rate is the percentage change in the price level from the previous period. Rate of inflation = [(Price in 2021 - Price in 2022) / Price in 2021]*100
Causes of Inflation in India:
Higher Fuel Prices due to an increase in International Crude Oil prices and an increase in taxes on Petroleum products.
Rising input cost
Emerging Food Crisis due to Russian- Ukrainian war.
The easy money policy adopted by RBI to fuel growth in India contributed to rising inflation.
Inflation is mainly caused either by demand Pull factors or Cost-Push factors. Apart from demand and supply factors, inflation sometimes is also caused by structural bottlenecks and policies of the government and the central banks. Therefore, the major causes of inflation are:
Demand-Pull Factors ( When aggregate demand exceeds Aggregate Supply at Full employment level).
Cost Pull Factors ( When Aggregate supply increases due to an increase in the cost of production while Aggregate demand remains the same).
Structural Bottlenecks ( Agriculture prices fluctuations, Weak Infrastructure etc.) Monetary Policy Intervention by the Central Banks.
Expansionary Fiscal Policy by the Government.
Demand and Supply factors can be further subdivided into the following:
Demand-pull inflation is mainly caused by an increase in aggregate demand. The increase in aggregate demand mainly comes from either increase in Government expenditure or an increase in expenditure from Households and firms. The root cause of demand-pull inflation is Aggregate demand more than Aggregate supply. The shortages of goods and services are due to an increase in demand-Pull inflation.
Cost Pull Inflation: There exists a situation in an economy where inflation is fuelled up, not because of an increase in Aggregate Demand but mainly due to an increase in the cost of producing goods and services.
Effect of Inflation on Employment: Inflation and unemployment have an inverse relationship according to the Phillips curve. As the Phillips curve shows, the lower a country's unemployment rate, the faster wages increase.
The Consumer Price Index is used to determine how the cost of living has changed over an extended period of time. As the CPI rises, families must spend more to maintain the same standard of living. Increasing prices of goods and services are considered inflation in economics.
Wholesale Price inflation: The WPI is a measure of the cost of goods and services purchased by producers and firms rather than by the final consumer. WPI inflation captures factory-level price changes.
The WPI and CPI are different indices and are used for different purposes.
The WPI and CPI use a different basket of goods to calculate inflation.
The weights assigned to food, fuel, manufacturing items etc. are different. For example, the weight of food in CPI is far higher at 46% than in WPI at 24%.
The WPI inflation does not capture price changes of services but the CPI does.
Different types of Inflation:
Stagflation: The situation of rising prices along with falling growth and employment is called stagflation.
Creeping Inflation: When prices are gently rising, it is referred to as Creeping Inflation. It is the mildest form of Inflation and is also known as Low Inflation.
Chronic Inflation: If creeping Inflation persists for a longer period of time then it is often called Chronic or Secular Inflation. If it continues for a longer time without any downturn, then it may lead to Hyperinflation.
Walking Inflation: When the rate of rising prices is more than Creeping Inflation, it is known as Walking Inflation.
Moderate inflation: When prices rise by less than 10% per annum, it is known as Moderate Inflation.
Running Inflation: A rapid acceleration in the rate of rising prices is referred to as Running Inflation.
Hyperinflation: It is a situation when inflation rises at an extremely fast rate.
Stagflation is a condition of slow economic growth and relatively high unemployment, or economic stagnation, accompanied by rising prices, or inflation.
Deflation: Deflation is when the overall price level in the economy falls for a period of time.
Disinflation: Disinflation is a situation in which the rate of inflation falls over a period of time. It is a fall in the inflation rate, not the overall price.
Headline Inflation: The headline inflation measure demonstrates overall inflation in the economy.
Core Inflation: The core inflation measures exclude the prices of highly volatile food and fuel components from the inflation index.
Central banks use inflation targeting to adjust monetary policy in order to achieve a specified annual inflation rate.
Steps to Control Inflation by RBI:
Inflation targeting is based on the belief that price stability and price stability are the keys to long-term economic growth. Currently, we are aiming for:
A target of 4% Consumer Price Index (CPI) inflation has been set by the Central Government, along with a tolerance limit of 6% and 2%, in consultation with the RBI.
In order to combat inflation, the Government of India took the following steps:
Decrease taxes on Fuel Prices.
Restriction on export of food items to tackle food price inflation as Prices of food rose 7.84 per cent, particularly vegetables (18.26 per cent), oil and fats (13.26 per cent) and spices (9.93 per cent). Additional upward pressure came from costs of transportation & communication (9.54 per cent); clothing (8.53 per cent) and health (5.49 per cent).
Price control and wage control by the government.
Contractionary monetary policy is a more popular method of controlling inflation. The goal of a contractionary policy is to reduce the money supply within an economy by increasing interest rates.
Government interventions can put a cap on prices, but the broad price controls required to impact inflation don't have a great track record. In order to control inflation, the measures adopted by the government have a negative impact on the growth prospects of India.
The way forward: According to experts, structural weaknesses in the Indian economy provide bottlenecks to long-term growth. A higher number of females joining the workforce, better educational outcomes, and improving the labour market are some of the bottlenecks in the labour market. By maintaining a balance between inflation and growth, the government can ensure sustained growth for many years to come.
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