Inflation generally means rise in prices.

Inflation is an increase in the price of a basket of goods and

services that is representative of the economy as a whole. It is a persistence and substantial rise in general
level of prices after full employment level of output
How India calculates Inflation? There are 2 methods: Wholesale Price Index (WPI) and Consumer Price
Index (CPI)
Wholesale Price Index: WPI is the index that is used to measure change in the average price level
of goods traded in wholesale market. In India, a total of 435 commodities data on price level is
tracked through WPI which is an indicator of movement in prices of commodities in all trade and
transactions.
Consumer Price Index (CPI): CPI is a statistical time-series measure of weighted average of
prices of a specific set of goods & services purchased by consumers
India uses the Wholesale Price Index (WPI) to calculate and then decide the inflation rate in
the economy.
Types of Inflation
On the Basis of Rate of Inflation:
Creeping Inflation: Rise in the price level at very low rate, or snails pace,
around 2-3% per annum is referred to as Creeping Inflation or Mild Inflation.
Walking Inflation: A sustained price increase from 3 to 7 or below 10% is
termed as Walking Inflation.
Running Inflation: A sustained price rise A sustained price rise from 10 to
20% per annum is known as Running Inflation
Hyperinflation: Running Inflation if not controlled turns into Hyperinflation
which is known as Galloping or Jumping
On the Basis of degree of control:
Open Inflation: Continuous rise in price without any interruption and control
from the government or any other authority is known as open inflation
Suppressed inflation: When price level in economy is not allowed to rise
(though conditions exist for rise) through the use of government policies like
price controls and rationing, it is known as suppressed inflation
On the Basis of causes of Inflation:
Demand pull Inflation: The Inflation caused due to demand pressures is known as Demand pull
Inflation
Causes: Increase in quantity of money, Increase in Business outlays or government expenditure,
Foreign expenditure on goods and services
Cost push Inflation: Increase in the overall price level due to cost pressures is known as costpush or supply side inflation.
Causes: Higher wage rates, Higher profit margins, Higher taxes, Higher prices of output

General causes of Inflation

Monetary factors: Expansion of money
supply
Expansion of Bank credit
Deficit financing
Increase in disposable
income
Increase in indirect taxes
Drop in exchange rate

Non-monetary factors: Rising population

Natural calamities
Speculation and Black money
Unfair practices by monoply houses
Poor performance of the farm sector
Bottlenecks and shortages such as
Infrastructure, capital and Foreign
exchange

Effects of inflation

On business community: Profit rises because of rising prices

Farmers usually gain during inflation, because they can get better prices for
their harvest during inflation
Investor- Fixed income recipient will be hurt : Those who invest in
debentures and fixed-interest bearing securities, bonds, etc, lose during
inflation. However, investors in equities benefit because more dividend is
yielded on account of high profit made by joint-stock companies during
inflation
Lower production
Banks increase Interest rates
Unemployment
Trade unions to demand higher wages
Higher uncertainty
Lower consumption -Fixed income recipient will be hurt : Since wages do
not rise at the same rate and at the same time as the general price level, the
cost of living index rises, and the real income of the wage earner decreases.
Lower national saving: Inflation will lead to deterioration of gross domestic
savings and less capital formation in the economy and less long term
economic growth rate of the economy
Winners? Not everyone loses with low and moderate rates of inflation.
People whose income is flexible - If their incomes rise as well, they
are double winners. Borrowers (debtors) - Borrowers win because the real
value of their loan repayments decreases at the same rate as inflation rises.
Balance of trade as Imports will increase than exports and so the economy
will have a deficit
There are two problems generated by inflation: uneveness and uncertainty
Uneveness: Inflation produces uneven increases in the prices of products. In periods of
inflation it is possible of have some products decrease in price, others increase slowly, while
others increase quickly. This means that some consumers are hurt worse than others. Buyers of
gasoline are hit worse than buyers of DVDs and computers .
People with fixed incomes will see their income fall at the same rate as inflation rises. Some
savers will see their savings fall almost as fast as the rate that inflation

Uncertainty: Who else is hurt by the uncertainty? Lenders banks, etc. Lenders lend money to
earn a profit. To earn a profit, the interest they charge must cover all costs, and be higher than the rate
of inflation. When lenders lend money, they have an expected rate of inflation at the time of the loan.
This expected rate of inflation is based on current rate of inflation, plus a guess about the future. If
lenders guess right about inflation, they earn a profit. If lenders guess wrong, they lose money.
Nominal interest rate = the observed interest rate
Real interest rate = nominal interest rate rate of inflation
Lenders try to set the nominal interest rate to:
inflation and 3) Yield a profit

1) Cover costs, 2) Match expected rate of

Why inflation is a cause of concern?

They create inefficiency in the markets & firms cannot plan from long term
perspective
It discourages saving and investment
Instability in currency exchange price
Higher income tax rates
Imports will increase than exports and so the economy will have a deficit
Currency debasement (which lowers the value of a currency, and sometimes
cause a new currency to be born)
Rising prices of imports (if the currency is debased, then its purchasing
power in the international market is lower).
How to control inflation? Two ways: Monetary measures and Fiscal measures
Monetary measures
A- Quantitative Methods
SLR/CRR
Interest rates/bank rate
OMO(open market
operations)
Margin Money
Repo Rate
B- Qualitative Methods Moral suasion
Rationing
Direct action
India Inflation Rate

Fiscal measures
Taxation-direct and indirect
Government expenditure
Public borrowings
The government can also take some
protectionist measures (such as banning
the export of essential items such as
pulses, cereals and oils to support the
domestic consumption, encourage
imports by lowering duties on import
items etc.).

 The inflation rate in India was last reported at 6.5 percent in December of
2011
From 1969 until 2010, the average inflation rate in India was 7.99 percent