Project on inflation on its impact on india companies and economy Submitted by: Arjun IIPM IIPM,SAKET,NEAR KVPV

C CONTENT 1.WHAT IS INFLATION? 2.INFLATION IN VARIOUS SECTOR OF INDIA 3.ITS IMPACT ON SAVING AND INVESTMENT? 4.ITS IMPACT ON AUTOMOBILE INDUSTRIES IN INDIA ? 5.ITS IMPACT ON INDIAN ECONOMY? 6.IMPACT ON COMPANY INVESTMENT?

7.HOW IT IS MEASURED? 8.CAUSES OF INFLATION 10.METHOD OF CONTROL 11. MONETARY PHENEMONEN

INFLATION Inflation can be defined as a rise in the general price level and therefore a fall in the value of

money. Inflation occurs when theamount of buying power is higher than the output of goods and services. Inflation also occurs when the amount of money exceedsthe amount of goods and services available. As to whether the fallin the value of money will affect the functions of money dependson the degree of the fall. Basically, refers to an increase in thesupply of currency or credit relative to the availability of goodsand services, resulting in higher prices. Therefore, inflation can be measured in terms of percentages. The percentage increase in the price index, as a

rate per cent per unit of time, which is usually in years. The two basic price indexes areused when measuring inflation, the producer price index (PPI) and the consumer price index (CPI) which is also known as the cost of living index number.
Effect of Inflation on Car Market Inflation always has a negative effect on the car market. The development of the car market comes to a standstill when there is inflation in the market. The effect of inflation on car

market is not at all encouraging and it badly affects every sector, which is associated with vehicle production and manufacturing. The hike in the rate of steel and fuel has resulted in a slower rate of development of the Indian automotive industry. One of the major effects of inflation is that the manufacturing of Indian cars has been hindered to a significant extent. It has also been witnessed that major Indian vehicle manufacturers such as Tata Motors, Mahindra and Mahindra, Hyundai, Maruti Suzuki, and Honda Siel Motors are attempting their best to improve their manufacturing and sales of the vehicles amidst the situation where the stock market is showing a sluggish growth. It has also been seen because of inflation that sales of particular vehicles are being

stimulated by the discounted rates that the car manufacturers are providing to the customers. Some of the vehicle makers have even resorted to offering exchange offers to the customers and some have launched competitive car financing rates. The effect of inflation has resulted in the hike of vehicle prices to the extent of 3%-4%, which sequentially is adequate for the necessity of meeting the hike of rates of raw materials for making an automobile.

The effect of inflation on car market has not only badly impacted the manufacturing and sales of Indian vehicles but also the vehicle dealers, employees, and vehicle financers. Surveys and studies have resulted in the conclusion that the vehicle market and the vehicle manufacturing industry in

India

experienced

8-9%

slump

due

to

inflation.

The effect of inflation on vehicle manufacturers have consequently affected the vehicle dealers in a manner where they are being forced to thrust the sales curve upward and maintain a high volume of profit. In this arrangement, the vehicle financers are compelled by both vehicle dealers and vehicle manufacturers to offer the customers a 100% financial assistance by lowering the interest rate of the loan. On the whole, it has been observed that the car market in India (both passenger car market and commercial vehicles market) has witnessed a slump with the inflation badly hitting

nearly every sector to which the Indian automobile market is closely associated. India and China car sales hit by inflation By Mary Watkins in Mumbai and Patti Waldmeir in Shanghai New car sales figures from India and China have highlighted the damaging impact of high fuel prices, inflationary pressures and supply bottlenecks on consumer spending in the worlds two largest emerging economies. The Society of Indian Automobile Manufacturers (SIAM) said that sales of cars in India in May rose 7 per cent to 158,817 compared with 148,425 the year before the slowest rate of growth in two years.

The deceleration shows how a combination of rising interest rates on car and home loans, as well as the higher cost of fuel and other essential items, is encouraging some Indian consumers to postpone discretionary purchases. India has raised interest rates nine times in just over a year as it tries to curb inflation. Petrol prices, meanwhile, rose nearly 9 per cent last month. In China, data released on Thursday showed that May car sales slipped 0.1 per cent year on year, confirming the substantial slowdown evident in the worlds largest auto market since small-car tax incentives were removed at the end of last year. Sales in the first five months rose 6.1 per cent year on year, compared with last years full-year growth rate of 32 per cent.

Given the headwinds present in recent months including rising fuel prices, limits on [vehicle] registrations in megacities, Japan earthquake supply shortages and the elimination of incentives, this is a actually a solid performance and indicates that the market is fundamentally strong, says Bill Russo, head of Synergistics auto consultancy and former head of Chrysler in China. Ivo Naumann, China head of AlixPartners, forecast recently that China light vehicle sales would grow 10 to 15 per cent this year despite the current slowdown, as more consumers become wealthy enough to own cars. SIAM said that, based on the current performance, hitting full-year targets would be difficult. The Indian industry body is forecasting that overall vehicle sales could grow at just 15

per cent in the year to March 2012, compared with 30 per cent last year. Jatin Chawla, an automotive analyst at IIFL in Mumbai, said he expected to see a slowdown in car sales in India in the next three to four months, adding that a strong pickup in the festive period from September onwards would be critical for carmakers. Mr Chawla said that Maruti Suzuki could expect to maintain market share as consumers stuck with more conservative carmakers that produced tried and tested models. Maruti which is currently trying to resolve a strike with workers at its Manesar plant in India who are trying to secure recognition for a new union recently reported a slowdown in car sales. Effect of inflation on india investment COMPANY

For world economic markets, inflation is a fairly new experience as for much of the pre-twentieth century there had been little upward pressure on prices due to gold and other metallic standards. These backed currencies limited governments abilities to create new money. So at the end of the gold standard strong political pressures often caused governments to issue more money increasing the money supply and therefor the price level. Inflation reflects a situation where the demand for goods and services exceeds their supply in the economy(Hall, 1982). Its causes could be triggered by the private sector and the government spending more than their revenues, or by shortfalls in output. Price increases could also be triggered by increases in

costs of production. For instance increases in prices of imported raw materials will cause inflation if not managed. Whatever the initial cause, inflation will not persist unless accompanied by sustained increase in money supply. In this sense, inflation is a monetary phenomenon. But what effect does inflation have on the economy and on investment in particular? Inflation causes many distortions in the economy. It hurts people who are retired and living on a fixed income. When prices rise these consumers cannot buy as much as they could previously. This discourages savings due to the fact that the money is worth more presently than in the future. This expectation reduces economic growth because the economy

needs a certain level of savings to finance investments which boosts economic growth. Also, inflation makes it harder for businesses to plan for the future. It is very difficult to decide how much to produce, because businesses cannot predict the demand for their product at the higher prices they will have to charge in order to cover their costs. High inflation not only disrupts the operation of a nation's financial institutions and markets, it also discourages their integration with the rest of the worlds markets. Inflation causes uncertainty about future prices, interest rates, and exchange rates, and this in turn increases the risks among potential trade partners, discouraging trade. As far as commercial banking is concerned, it erodes the value of the depositor's savings as well as that of the bank's loans. The

uncertainty associated with inflation increases the risk associated with the investment and production activity of firms and markets. The impact inflation has on a portfolio depends on the type of securities held there. Investing only in stocks one may not have to worry about inflation. In the long run, a companys revenue and earnings should increase at the same pace as inflation. But inflation can discourage investors by reducing their confidence in investments that take a long time to mature. The main problem with stocks and inflation is that a company's returns can be overstated. When there is high inflation, a company may look like it's doing a great job, when really inflation is the reason

behind the growth. In addition to this, when analyzing the earnings of a firm, inflation can be problematic depending on what technique the company is uses to value its inventory. The effect of inflation on investment occurs directly and indirectly. Inflation increases transactions and information costs, which directly inhibits economic development. For example, when inflation makes nominal values uncertain, investment planning becomes difficult. Individuals may be reluctant to enter into contracts when inflation cannot be predicted making relative prices uncertain. This reluctance to enter into contracts over time will inhibit investment which will affect economic growth. In this case inflation will inhibit investment and could

result in financial recession(Hellerstein, 1997). In an inflationary environment intermediaries will be less eager to provide longterm financing for capital formation and growth. Both lenders and borrowers will also be less willing to enter long-term contracts. High inflation is often associated with financial repression as governments take actions to protect certain sectors of the economy. For example, interest rate ceilings are common in high inflation environments. Such controls lead to inefficient allocations of capital that inhibit economic growth The hardest hit from inflation falls on the fixed-income investors. For example, suppose one year ago an investor buys a $1,000 Tbill that yields 10%. When they collect the $1,100 owed to them,

is their $100 (10%) return real? No, assuming inflation was positive for the year, the purchasing power of the investor has fallen and thus so has the real return. The amount inflation has taken out of the return has to be taken into account. If inflation was 4%, then the return is really 6%. By the Fisher equation (nominal interest rate inflation rate = real interest rate) we see the difference between the nominal interest rate and the real interest rate. The nominal interest rate is the growth rate of the investors money, while the real interest rate is the growth of their purchasing power. In other words, the real rate of interest is the nominal rate reduced by the rate of inflation. Here the nominal rate is 10% and the real rate is 6% (10% - 4% = 6%).

Inflation causes anxiety particularly for retirees who are uneasy about inflation adjustments to their pensions and financial investments. Planning for retirement requires expectations of future prices. Inflation makes this more difficult because even a series of small, unanticipated increases in the general price level can significantly erode the real value of savings over time. Social Security payments are now indexed to inflation, a policy change that has reduced the effects of inflation uncertainty on retirement. There are securities that offer investors the guarantee that returns are not eaten up by inflation. Treasury Inflation-

Protected Securities are a special type of Treasury note or bond that offers protection from inflation. With a regular Treasury bond, interest payments are fixed, and only the principal fluctuates with the movement of interest rates. The yield on a regular bond incorporates investors' expectations for inflation. So at times of low inflation, yields are generally low, and they generally rise when inflation does. Treasury Inflation-Protected Securities are like any other Treasury bills, except that the principal and coupon payments are tied to the consumer price index (CPI) and increased to compensate for any inflation. As with other Treasury notes, when you buy an inflation-protected or inflation-indexed

security, you receive interest payments every six months and a principal payment when the security matures. The difference is that the coupon payments and underlying principal are automatically increased to compensate for inflation by tracking the consumer price index (CPI). Treasury Inflation-Protected Securities are the safest bonds in which to invest. This is because the real rate of return, which represents the growth of purchasing power, is guaranteed. The downside is that because of this safety and the lower risk, inflation-protected bonds offer a lower return. Sustained inflation is damaging to long-run growth and the financial system in general. Increases in inflation lead to lower

real returns not just on money, but on all other assets too. These low returns interfere with the functioning of financial markets and the allocation of investment. Lower real returns have the effect of severely damaging the credit market. As a result, higher inflation contracts the supply of credit available to fund capital investment damaging the economy(Blume, 1978). It has been shown that inflation affects investment in several ways, mostly inhibiting economic growth. The source of inflation is money and the supply of it. Investors need to be able to expect returns in order for them to make financial decisions. If people cannot trust money then they are less likely to engage in business relationships. This results in lower investment,

production and less socially positive interactions. Among other effects, people may start to attempt to trade by other, less efficient, means in order to avoid the unpredictable price levels due to inflation.

Effect of inflation on our saving and investment Inflation affects your earnings, your investments, what you can purchase and your lifestyle. It may seem like a technical concept best left to economists to discuss, but heres why you need to know more about it. In March 2010 various agencies are expected to assess inflation for the fiscal year of 2009-2010 at anywhere from around 6.5% (RBI

estimate as of October 09 policy review) to 8% (as per Citi economist Rohini Malkani, noted Dec 14, 2009 in the Economic Times). That means, since the previous tax year, on average goods and services in India will cost from 6.5% to 8% more than the previous year. With luck, you may have had a salary increase of that amount to keep up with your lifestyle expenses. With the economic downturn, you may not have had the increase. What about your investments? If you held a diversified portfolio with debt and equity and earned around 15%, you are doing well. You earned money in real terms. Anything more than that is icing on the cake (provided the investment continues to do well, that is, or you sell it). If you held all your money in FDs yielding 6% to 7%

or in a cash account at the bank earning 3% to 4%, then you actually lost money this year. You will be able to purchase less for the same price than you could last year. This concept is hard to accept: you want your money to be safe and stable but in going the totally safe route, you may be losing money long term. Many Debt products can be safe options and return a bit more than inflation. A Provident fund investment (obligatory for many in large companies) earns currently around 8%. We are not discounting debt and other safe options for your moneyit is an important part of every portfolio, giving stability through assured returns, safety through the fact that it is a noncorrelated asset (meaning debt wont decrease in value when shares do, usually it will increase in value) and an assurance that it will be there no matter what. If all the companies that we invest in through

mutual funds and/or directly, went bankrupt (obviously not likely), in theory, the Provident Fund and other debt options would still be there to see you through. Really the best option, however is to be sure you have enough diversity in your portfolio to allow for growth, best captured through equity. Equity tends to grow faster than debt and usually outpaces inflation. Inflation is more important for emerging markets like India than developed markets. The currency, economy, prices and general economic system are more volatile and growing faster and will generally produce sharp swings in inflation that must be closely monitored. If you watch carefully, invest well and are well advised, you can do well. In a highly inflationary environment, investments will often also earn higher returns to reward investors.

Inflation is often matched by fast growth rates which produce good earnings for companies that people and mutual funds invest in. But it musnt get out of control. This is why the government closely monitors inflation to make sure it wont get too high. If it does, watch for fiscal and monetary policies like taxing inflows of foreign dollars, raising interest rates and removing any stimulus measures put in place during the economic slowdown. One impact of the very slow to negative growth we are currently seeing in many of the Western countries is near zero inflation. It corresponds to growth. This is why inflation is not static. Inflation for assessment year 2007-2008 was 4.5%. It changes all the time and we are not able to predict it with great accuracy. This is why it helps to keep an eye on it.

Another factor to be aware of is how uneven inflation can be. Education costs in both the USA and in India have far outpaced average inflation for many years. At InvestmentYogi in our financial plans, we currently use an inflation figure of 6% (this represents a historical average with future predicted inflation factored in) and an education inflation figure of 10%. This is important when planning your childs higher education, whether in India or abroad. Food prices worldwide also fall in the higher inflation rates (for November alone increase was 19% as per Economic Times of Dec 14), and are expected to for years to come, while other consumer goods may not have changed prices or may have gone down. Retirement is a key area to watch out for. You must save large amounts and save early in order for earnings and compounded growth to increase sufficiently to support you in your old age.

Think about 7% (if inflation stays there!) per year for the next 40 years. Just make sure that money is diversified in your investments! And for current retirees, they need to have access to Safe money but woe to those who dont hold some equity and are looking at the next 20 years in retirement. That is a long time to make your money last in a world of rising prices. The era of company-offered pensions is declining and one must look out for oneself. Even those with a pension will fast find its value eroding if the pension amount is fixed and the economy is not. Aside from diversification, there are some other tools to look for. Pension funds you can buy generally track inflation, as do some other investments. This is a sort of guarantee that inflation will not outpace your funds.

Whatever your strategy, be aware of the inflation rate and make sure you are keeping up with it, if not surpassing it, in your investments and other earnings. And be sure to talk to your elders about these concepts, which may be foreign to them. Older people tend to prefer safe investments but make sure they are not being so safe that they lose money! Once their earning power is gone, they need the money more than anyone else. Effect on indian economy A low inflation rate is beneficial to a country and zero or negative inflation is considered as bad. Also, a high inflation is harmful to an economy and it affects an economy in many ways. High inflation distorts consumer behavior. Because of the fear of price increases, people tend to purchase their

requirements in advance as much as possible. This can destabilize markets creating unnecessary shortages. High inflation redistributes the income of people. The fixed income earners and those lacking bargaining power will become relatively worse off as their purchasing power falls. Trade unions may demand for higher wages at times of high inflation. If the claims are accepted by the employers, it may give rise to a wage-price spiral which may aggravate the inflation problem. During a high inflation period, wide fluctuations in the inflation rate make it difficult for business organizations to predict the future and accurately calculate prices and returns from investments. Therefore, it can undermine business confidence.

When inflation in a country is more than that in a competitive country, the exports from former country will be less attractive compared to the other country. This means there will be less sales for that countrys goods both at home and abroad and that will create a larger trade deficit. At the same time, high inflation in a country weakens its competitive position in the international market.

HOW INFLATION IS MEASURED? Inflation is normally given as a percentage and generally in yearsor in some

instances quarterly and is derived from the Consumer Price Index (CPI).However, there are two main indices used to measure inflation.The first is the Consumer Price Index, or the CPI. The CPI is a measure of the price of a set group of goods and services. The"bundle," as the group is known, contains items such as food, clothing, gasoline, and even computers. The amount of inflation ismeasured by the change in the cost of the bundle: if it costs 5%more to purchase the bundle than it did one year before, there has been a 5% annual rate of inflation over that period based ont h e CPI. You will also often hear about the "Core Rate" o r t h e "Core CPI." There are certain items in the bundle used to measurethe CPI that are extremely volatile, such as gasoline prices. By eliminating the items that can significantly affect the cost of thebundle (in either direction) on a month-

to-month basis, the Corerate is thought to be a better indicator of real inflation, the slow,but steady increase in the price of goods and services. The second measure of inflation is the Producer Price Index, or thePPI. While the CPI indicates the change in the purchasing power of a consumer, the PPI measures the change in the purchasing power of the producers of those goods. The PPI measures how much producers of products are getting on the wholesale level, i.e. the price at which a good is sold to other businesses before the good i s s o l d t o a c o n s u m e r . T h e P P I a c t u a l l y c o m b i n e s a s e r i e s o f smaller indices that cross many industries and measure the pricesf o r t h r e e t y p e s of goods: crude, intermediate and f i n i s h e d . Generally, the markets are most co ncerned with the finished goods because these are a strong

indicator of what will happenwith future CPI reports. The CPI is a more popular measure of inflation than the PPI, but investors watch both closely

TYPES OF INFLATION:

Subsequently, when either the prices of goods or services or thesupply of money rises; this is considered as inflation. Dependingon the characteristics and the intensity of inflation, there are several types, namely. Creeping inflation Trotting inflation Galloping inflation Hyper inflation

When there is a general rise in prices at very low rates, which isusually between 2-4 percent annually, this is known as creepinginflation.Whereas, trotting inflation occurs when the percentage has risenfrom 5 to almost percent. At this level it is a warning signal for most governments to take measures to avoid exceeding double-digit figures. Another type of inflation is the galloping inflation, where the rateof inflation is increasing at a noticeable speed and at a remarkablerate, usually from 10-20 percent.However, when the inflation rate rises to over 20% it is generally c o n s i d e r e d a s h y p e r i n f l a t i o n a n d a t t h i s s t a g e i t i s a l m o s t uncontrollable because it increases more rapidly in such a littletime frame.

The main difference between the galloping and hyper inflation, is

that hyperinflation occurs when prices rise at any moment and there is no level to which the prices might rise.D u r i n g World War II certain countries e x p e r i e n c e d a hyperinflation, where the price

i n d e x r o s e f r o m 1 t o o v e r 1,000,000,000 in Germany during January 1922 to November 1923. CAUSES OF INFLATION Inflation comes in different forms and those at are familiar withthe economic matters would observe that there are trends in theway that prices are moving gradual and irregular in relation toaggregate sections of the economy. This suggest that there is m o r e t h a n o n e f a c t o r t h a t c a u s e s i n f l a t i o n a n d a s d i f f e r e n t sections of the economy develop it gives rise to different typesinflationary periods. The main causes of inflation are: Demand-pull Inflation Cost push Inflation Monetary inflation

Structural inflation Imported inflation DEMAND-PULL INFLATION Demand-pull inflation occurs when the consumers, businesses or the governments demand for goods and servi ces exceed thes u p p l y ; t h e r e f o r e t h e c o s t o f t h e i t e m rises, unless supply is perfectly elastic. Because we d o n o t l i v e i n a p e r f e c t m a r k e t supply is somewhat inelastic and the supply of goods and servicescan only be increased if the factors of production are increased.The increase in demand is created from in increase in other areas,such as the supply of money, the increase of wages which would then give

rise in disposable income, and once the consumers havemore disposal income this would lead to aggregate spending. As a result of the aggregate spending there would also be an increasein demand for exports and possible hoarding and profiteering from producers. The excessive demand, the prices of final goods and services would be forced to increase and this increase gives riseto inflation.

COST-PUSH INFLATION Cost-push inflation is caused by an increase in production costs. It is generally caused by an increase in wages or an increase in the profit

margins of the entrepreneurs.When wages are increased, this causes the business owner to inturn increase the price of final goods and services which would be passed onto the consumers and the same consumers are also theemployees. As a result of the increase in prices for final goods and services the employees realise that their income is insufficient tomeet their standard of living because the basic cost of living hasi n c r e a s e d . T h e t r a d e u n i o n s t h e n a c t a s t h e mediator for thee m p l o y e e s a n d n e g o t i a t e b e t t e r w a g e s a n d c o n d i t i o n s o f employment. If the negotiations are successful and the employeesare given the requested wage increase this would further affect the prices of goods and services and invariably affected.On the other hand, when firms attempt to increase their profit margins by making the prices more responsive

to supply of a good or service instead of the demand for that said good or service.This is usually done regardless to the state of the economy.

MONETARY INFLATION Monetary inflation is a sustained increase in the money supply of a country. It usually results in price inflation, which is a rise in the general level of prices of goods and services. Originally the term "inflation" was used to refer only to monetary inflation, whereas in present usage it usually refers to price inflation.[1] There is general agreement among economists that there is a causal relationship between the supply and demand of money, and prices of goods and services measured in monetary terms, but there is no

overall agreement about the exact mechanism and relationship between price inflation and monetary inflation. The system is complex and there is a great deal of argument on the issues involved, such as how to measure the monetary base, or how much factors like the velocity of money affect the relationship, and what the best monetary policy is. However, there is a general consensus on the importance and responsibility of central banks and monetary authorities in affecting inflation. Keynesian economists favor monetary policies that attempt to even out the ups and downs of the business cycle. Currently, most central banks follow such a rule, adjusting monetary policy in response to unemployment and inflation (see Taylor rule). Followers of the monetarist school advocate either inflation targeting or a constant growth rate of money supply, while Austrian economists advocate the return to

free markets in money, which would entail free banking or a return to a 100 percent gold standard and the abolition of central banks. STRUCTURAL INFLATION Inflation of an economic system that results from the monetary policy pursued by a country's government. Structural inflation will have a bearing on the decisions made by forex traders regarding the currency linked to that economic system. IMPORTED INFLATION Inflation due to an increase in the price of imports. As the price of imports increase, prices of domestic goods using imports as raw materials also increase, causing an increase in the general prices of

all goods and services. Imported inflation may be caused by foreign price increases or depreciation of a country's exchange rate.

EFFECT OF INFLATION SHOWN IN GRAPH

EFFECT OF INFLATION ON INDIA

EFFECT OF INFLATION Inflation can have positiveand negative effects on an economy . Negative effects of inflation include loss in stability in the realvalue 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 goodsif consumers beginhoardingout of concern that prices will increase in the future.Positive effects include a mitigation of economicrecessions, and debt relief by reducing the real level of debt.Most effects of

inflation are negative, and can hurt individuals and companies alike, below are a list of negative and positive effectsof inflation: NEGATIVE EFFECTS OF INFLATION

1. 2. 3.

Causes an increase in tax bracket (people will be taxed ahigher percentage if their income increases following aninflation increase). Causes mal-investment (in inflation times, the data givenabout an investment is often deceptive and unreliable,therefore causing losses in investments). Causes business cycles (many companies will have to go out of business because of the losses they incurred from inflationand its effects)

4.

Rising prices of imports (if the currency is debased, then its purchasing power in the international market is lower).

"POSITIVE" EFFECTS OF INFLATION ARE: 1. It can benefit the inflators (those responsible for the inflation) 2. It be benefit early and first recipients of the inflated money (because the negative effects of inflation are not there yet) 3. It can benefit the cartels (it benefits big cartels, destroyssmall sellers, and can cause price control set by the cartelsfor their

4. It might relatively benefit borrowers who will have to pay thesame amount of money they borrowed (+ fixed interests),but the inflation could be higher than the interests, thereforethey will be paying less money back. (example, you borrowed $1000 in 2005 with a 5% fixed interest rate and you paid it back in full in 2007, lets suppose the inflation rate for 2005,2006 and 2007 has been 15%, you were charged %5 of interests, but in reality, you were earning %10 of interests,because 15% (inflation rate) 5% (interests) = %10 profit,which means you have paid only 70% of the real value in the3 years.Note: Banks are aware of this problem, and when inflationrises, their interest rates might rise as well. So don't take out loans based on this information. 5. Many economists favor a low steady rate of inflation, low (asopposed to zero or negative) inflation may reduce theseverity of economic recessions by enabling the labor market to adjust

more quickly in a downturn, and reducing the risk that a liquidity trap prevents monetary policy from stabilizingthe economy. The task of keeping the rate of inflation lowand stable is usually given to monetary authorities.Generally, these monetary authorities are the central banksthat control the size of the money supply through the settingof interest rates, through open market operations, and through the setting of banking reserve requirements 6. To bin effect argues that: a moderate level of inflation canincrease investment in an economy leading to faster growth or at least higher steady state level of income. This is due to the fact that inflation lowers the return on monetary assets relative to real assets, such as physical capital. To avoid inflation, investors would switch from holding their assets as money (or a

similar, susceptible to inflation, form) to investing in real capital projects.

METHODS TO CONTROL A high inflation rate is undesirable because it has n e g a t i v e consequences. However, the remedy for such inflation depends ont h e c a u s e . T h e r e f o r e , g o v e r n m e n t m u s t d i a g n o s e i t s c a u s e s before implementing policies. MONETARY POLICY Inflation is primarily a monetary phenomenon. Hence, the most logical solution to check inflation is to check the flow

of money supply by devising appropriate monetary policy and carefully implementing such measures. To control inflation, it is necessary to control total expenditures because under conditions of fullemployment, increase in total expenditures will be reflected in ageneral rise in prices, that is, inflation. Monetary policy is used tocontrol inflation and is based on the assumption that a ris e in p r i c e s i s d u e t o e x c e s s o f m o n e t a r y d e m a n d f o r g o o d s a n d services by the consumers/households e because easy bank credit is available to them. Monetary policy, thus, pertains to bankingand credit availability of loans to firms and households, interest r a t e s , p u b l i c d e b t a n d i t s m a n a g e m e n t , a n d

t h e m o n e t a r y standard. Monetary management is aimed at the commercialbanking systems, and through this action, its effects are primarily felt in the economy as a whole. By directly affecting the volume of cash reserves of the banks, can regulate the supply of money and c r e d i t i n t h e economy, thereby influencing the structure o f interest rates and the availability of credit. Both these, factors a f f e c t t h e c o m p o n e n t s o f a g g r e g a t e d e m a n d a n d t h e f l o w o f expenditure in the economy. The central banks monetary management methods, the devicesfor decreasing or increasing the supply of money and credit for m o n e t a r y s t a b i l i t y i s c a l l e d m o n e t a r y p o l i c y . C e n t r a l b a n k s generally use the three quantitative

measures to control thevolume of credit in an economy, namely: 1.Raising bank rates 2.Open market operations and 3.Variable reserve ratio However, there are various limitations on the effective working of the quantitative measures of credit control adapted by the centralbanks and, to that extent, monetary measures to control inflationare weakened. In fact, in controlling inflation moderate monetary measures, by themselves, are relatively ineffective. On the other hand, drastic monetary measures are not good for the

economicsystem because they may easily send the economy into a decline.In a developing economy there is always an increasing need for credit. Growth requires credit expansion but to check inflation,there is need to contract credit. In such an encounter, the best course is to resort to credit control, restricting the flow of credit into the unproductive, inflation-infected sectors and speculativeactivities, and diversifying the flow of credit towards the most desirable needs of productive and growth-inducing sector. It should be noted that the impression that the rate of spendingcan be controlled rigorously by the contraction of credit or money supply is wrong in the context of modern economic societies. Inmodern community, tangible, wealth is typically represented by claims in the form of securities, bonds, etc., or

near moneys, asthey are called. Such near moneys are highly liquid assets, and they are very close to being money. They increase the generall i q u i d i t y o f t h e e c o n o m y . I n t h e s e c i r c u m s t a n c e s , i t i s n o t s o simple to control the rate of spending or total outlays merely by controlling the quantity of money. Thus, there is no immediateand direct relationship between money supply and the price level,as is normally conceived by the traditional quantity theories.When there is inflation in an economy, monetary restraints can, inconjunction with other measures, play a useful role in controlling inflation. FISCAL MEASURES

Fiscal policy is another type of budgetary policy in relation totaxation, public borrowing, and public expenditure. To curve theeffects of inflation and chang es in the total expenditure, fiscalm e a s u r e s w o u l d h a v e t o b e i m p l e m e n t e d w h i c h i n v o l v e s a n increase in taxation and decrease in government spending. Duringinflationary periods the government is supposed to counteract anincrease in private spending. It can be cleared noted that during a period of full employment inflation, the aggregate demand in elation to the limited supply of goods and services is reduced tothe extent that government expenditures are shortened. Along with public expenditure, governments must simultaneously increase taxes that would effectively reduce

private expenditure,in an effect to minimise inflationary pressures. It is known that when more taxes are imposed, the size of the disposable incomediminishes, also the magnitude of the inflationary gap in regardsto the availability of the supply of goods and services. I n s o m e i n s t a n c e s , t a x p o l i c y h a s b e e n d i r e c t e d t o w a r d s restricting demand without restricting level of production. For example, excise duties or sales tax on various commodities may take away the buying power from the consumer goods market without discouraging the level of production. However, someeconomists point out that this is not a correct way of combatinginflation because it may lead to a regressive status within the economy. As a

result, this may lead to a further rise in prices of goods and services, and inflation can spread from one sector of the economy to another and from one type of goods and services to another.Therefore, a reduction in public expenditure, and an increase intaxes produces a cash surplus in the budget. Keynes, however,suggested a programme of compulsory savings, such as deferred pay as an anti-inflationary measure. Additionally, private savings have a strong disinflationary effect onthe economy and an increase in these is an important measure for controlling inflation. Government policy should therefore, includedevices for increasing savings. A strong savings drive reduces thespendable income of the consumers, without any harmful effectsof any kind that are associated with higher

taxation.Furthermore, the effects of a large deficit budget, which is mainly responsible for inflation, can be partially offset by covering thedeficit through public borrowings. It should be noted that it is only g o v e r n m e n t b o r r o w i n g f r o m n o n - b a n k l e n d e r s t h a t h a s a disinflationary effect. In addition, public debt may be managed ins u c h a way that the supply of money in the country may b e controlled. The government should avoid paying back any of its past loans durin g inflationary periods, in order to prevent ani n c r e a s e i n t h e c i r c u l a t i o n o f m o n e y . A n t i - i n f l a t i o n a r y d e b t management also includes cancellation of public debt held by thecentral bank out of a budgetary surplus. Fiscal policy by itself may not be ver y

effective in combatinginflation; therefore a combination of fiscal and monetary tools canwork together in achieving the desired outcome.

DIRECT MEASURES OF CONTROL

Direct controls refer to the regulatory measures undertaken toconvert an open inflation into a repressed one.Such regulatory measures involve the use of direct control on prices and rationing of scarce goods. The function of price controlis a fix a legal ceiling, beyond which prices of particular goodsmay not increase. When ceiling prices are fixed and enforced, it means prices are not allowed to rise further and so, inflation issuppressed.Under price control, producers cannot raise the price beyond a specified level, even though there may be a pressure of excessivedemand forcing it up. For example, during wartimes, price controlwas used to suppress inflation.

In times of the severe scarcity of certain goods, particularly, food grains, government may have to enforce rationi ng, along with p r i c e c o n t r o l . T h e m a i n f u n c t i o n o f r a t i o n i n g i s t o d i v e r t consumption from those commodities whose supply needs to ber e s t r i c t e d f o r some special reasons; such as, to make t h e commodity more available to a larger number of households.Therefore, rationing becomes essential when necessities, such asfood grains, are relatively scarce. Rationing has the effect of limiting the variety of

quantity of goods available for the good cause of price stability and distributive impartiality. However,according to Keynes, rationing involves a great deal of waste,both of resources and of employment. In times of the severe scarcity of certain goods, particularly, food grains, government may have to enforce rationi ng, along with p r i c e c o n t r o l . T h e m a i n f u n c t i o n o f r a t i o n i n g i s t o d i v e r t consumption from those commodities whose supply needs to ber e s t r i c t e d f o r some special reasons; such as, to make t h e commodity more available to a larger number of households.Therefore, rationing becomes essential when necessities, such asfood grains, are relatively scarce.

Rationing has the effect of limiting the variety of quantity of goods available for the good cause of price stability and distributive impartiality. However,according to Keynes, rationing involves a great deal of waste,both of resources and of employment. corrections through periodic adjustments in money incomes of the p e o p l e a n d i n t h e v a l u e s o f f i n a n c i a l a s s e t s s u c h a s s a v i n g s deposits, which are held by them in relation to the degrees of price rise. Basically, if the annual price were to rise to 20%, themoney incomes and values of financial assets are enhanced by 20%, under the system of indexing.Indexing also saves the government from public wrath due tosevere inflation persisting over a long period. Critics, however, donot favour indexing, as it does not

cure inflation but rather it e n c o u r a g e s l i v i n g w i t h i n f l a t i o n . T h e r e f o r e , i t i s a h i g h l y discretionary method.In general, monetary and fiscal controls may be used to repressexcess demand but direct controls can be more useful when they are applied to specific scarcity areas. As a result, anti-inflationary policies should involve varied programmes and cannot exclusively depend on a particular type of measure only. OTHER MONETARY PHENOMENA In Keynes view, rising prices in all situations cannot be termed asinflation. In a condition of under-employment, when an increase inmoney supply and rising prices are accompanied by the expansionof output and employment, but when1here are bottlenecks in theeconomy, an increase in money supply may

cause cost and pricesto rise more than the expansion of output and employment. Thismay be termed as semi-inflation or reflation till the ceiling of f u l l e m p l o y m e n t i s r e a c h e d . O n c e f u l l e m p l o y m e n t l e v e l i s reached, the entire increase in money supply is reflected simply by the rising prices - the real inflation.Incidentally, Keynes mentions the following four related termswhile discussing the concept of inflation: _Deflation Disinflation Reflation Stagflation DEFLATION It is a condition of falling prices accompanied by a decreasinglevel of employment, output and income. Deflation is just theopposite of inflation. Deflation occurs

when the total expenditure o f t h e c o m m u n i t y i s n o t e q u a l t o t h e e x i s t i n g p r i c e s . Consequently, the supply of money dec reases and as a result p r i c e s f a l l . Deflation can also be brought about by d i r e c t contractions in spending, either in the form o f a r e d u c t i o n i n government spending, personal spending or investment spending.D e f l a t i o n h a s o f t e n h a d t h e s i d e e f f e c t o f i n c r e a s i n g unemployment in an economy, since the process often leads to alower level of demand in the economy. However, each and every fall in price cannot be called deflation. The process of reversinginflation without either creating unemployment or reducing output is called disinflation and not deflation.

Therefore, some perceivedeflation as an underemployment phenomenon.

DISINFLATION When prices are falling due to anti-inflationary measures adopted by the authorities, with no corresponding decline in the existinglevel of employment, output and income, the result of this isdisinflation. When acute inflation burdens an economy, disinflationis implemented as a cure. Disinflation is said to take place whendeliberate attempts are made to curtail expenditure of all sorts tolower prices and money incomes for the benefit of the community.

REFLATION Reflation is a situation of rising prices, which is deliberately undertaken to relieve a depression. Reflation is a means of m o t i v a t i n g t h e e c o n o m y t o p r o d u c e . T h i s i s a c h i e v e d b y increasing the supply of money or in some instances reducing taxes, which is the opposite of disinflation. Governments can useeconomic policies such as reducing taxes, changing the supply of money or adjusting the interest rates; which in turn motivates thecountry to increase their output. The situation is described assemi-inflation or reflation.

STAGFLATION Stagflation is a stagnant economy that is combined with inflation.Basically, when prices are increasing the economy is deceasing.Some economists believe that there are two main reasons for stagflation. Firstly, stagflation can occur when an economy isslowed by an unfavourable supply, such as an increase in the price of oil in an oil importing country, which tends to raise pricesat the same time that it slows the economy by making productionless profitable. In the 1970's inflation and recession occurred indifferent economies at the same time. Basically, what happened was that there was plenty of liquidity in the system

and peoplewere spending money as quickly as they got it because priceswere going up quickly. This gav e rise to the second reason for stagflation.