INFLATIO

N
 INDEX

TOPIC CONTRIBUTION BY

Concept of Inflation Jithin Prabhakaran

Rate of Inflation & Rate of Return Royston Martis

Kinds of Inflation Minal Khochare

Causes of Inflation Nikhil Limaye

Measures to control Inflation Priyanka Patil &

Chandra M
 INFLATION
The word "inflation" covers two different concepts, and it's important to keep them
separate. One concept is monetary inflation, which is when the supply of money
increases faster than the supply of goods and services.

According to Pigou, “Inflation exists when money income is expanding more than in
proportion to increase in earning activity.”

According to Coulborn, “Too much money chasing too few goods”.

CONCEPT OF INFLATION
The other concept is price inflation, which is an increase in the overall level of prices
for goods and services. The relationship between the two is the relationship of cause
and effect. Monetary inflation causes price inflation. But while almost everyone sees
price inflation when it happens, few people notice the monetary inflation that is
causing it. And so they tend to blame the producers of goods and services for higher
prices - rather than the money-creating government that is the true culprit.
For example:
➢ A movie ticket was for a few paisas in my dad’s time. Now it is worth Rs.50.
➢ My dad’s first salary for the month was Rs.400 and over his years it has now
become Rs.75, 000.
This is what inflation is, the price of everything goes up. Because the price goes up,
the salaries go up.
If you really thing about it, inflation makes the worth of money reduce. What you
could buy in my dad’s time for Rs.10, now a days you will not be able to buy for
Rs.400 also. The worth of money has reduced! If this is still not clear consider this,
when my father was a kid, he used to get 50paise pocket money. He used to use this
money to go and watch a movie (At that time you could watch a movie for 50paise!)

Now, just for the sake of understanding assume that my dad decided in his
childhood to save 50paise thinking, that one day when he becomes big, he will go for
a movie. Many years pass. The year now is 2006. My dad goes to the theater and
asks for a ticket. He offers the ticket-booth-guy at the theater 50paise and asks for a
ticket. The ticket booth guy says, “I am sorry sir, the ticket is worth Rs.50. You will
not be able to even buy a “paan” with the 50 paisa!!”
The moral of the story is that, the worth of the 50paise reduced dramatically.
50paise could buy a whole lot when my dad was a kid. Now, 50paise can buy
nothing. This is inflation. This tells us two important things.
Firstly:
Do not keep your money stagnant. If you just save money by putting it your safe it
will loose value over time. If you have Rs.1000 in your safe today and you keep it
there for 10years or so, it will be worth a lot less after 10 years. If you can buy
something for Rs.1000 today, you will probably require Rs.1500 to buy it 10 years
from now. So do not keep money locked up in your safe.
Always invest money.
If you can’t think where to invest your money, then put it in a bank. Let it grow by
gaining interest. But whatever you do, do not just lock your money up in your safe
and keep it stagnant. If you do this, you will be loosing money without even knowing
it. The more money you keep stagnant the more money you will be loosing.

Secondly:
When investing, you have to make sure that the rate of return on your investment is
higher than the rate of inflation.

What is the rate of inflation?

As we said earlier, the prices of everything go up over time and this phenomenon is
called inflation.
The question is: By how much do the prices go up? At what rate do the prices do
up?

The rate at which the prices of everything go up is called the "rate of inflation". For
example, if the price of something is Rs.100 this year and next year the price
becomes approximately Rs.104 then the rate of inflation is 4%. If the price of
something is Rs.80 then after a year with a rate of inflation of 4% the price go up to
(80 x 1.04) = 83.2

So, when you make an investment, make sure that your rate of return on the
investment is higher than the rate of inflation in your country. In our county India,
for the year 2005-2006 the rate of inflation was 4% (Which is really low and
amazing!). This rate keeps changing every year. The finance minister generally
gives the official statement on the inflation rate of the country for a particular year.

What is the rate of return?

The rate of return is how much you make on an investment. Suppose you invest
Rs.100 in the market and over a year, you make Rs.120, then you rate of return is
20%.

If you invest Rs.100 in the market today and you make money at a 3% "rate of
return" in one year you will have Rs.103. But now, since the rate of inflation is at
4%, an item costing Rs.100 today will cost Rs.104 a year from now. So what you can
buy with today’s Rs.100, you will only be able to buy with Rs.104 a year from now.

But the Rs.100 that you invested has grown only at a 3% rate of return and so it is
worth Rs.103. In effect, you are loosing money!

So in conclusion, the rate of return on your investments, have to be higher than the
rate of inflation.

From the above paragraphs you can note how silently, inflation eats into your
money. You would not even know about it and your money would sit loosing value
for no fault of yours.

KINDS OF INFLATION
➢ Moderate Inflation
➢ Galloping Inflation
➢ Hyper Inflation

1. Moderate Inflation:
A ‘single digit’ rate of annual inflation is called ‘moderate
inflation’ or creeping inflation. During the period of moderate inflation
price increases, but at a moderate rate. The moderate rate may vary from
country to country. However an important feature of moderate inflation
is that it is predictable and people hold money as a store of value. By this
definition India has had a moderate rate of inflation during the post
independence period except in few years.

2. Galloping Inflation:
Very high rate of inflation is called galloping inflation. How
high should be the rate of inflation to be called a galloping inflation is not
defined precisely? According to Baumol and Blinder galloping inflation
refers to an inflation that proceeds at an exceptionally high rate. They do
not specify at what rate of inflation is exceptionally high. A country with
900 percent inflation will have devastating effects, whereas countries with
20-30 percent can mange without pressing the alarm bell. Some examples
of galloping inflation, i.e., the annual average rate of inflation, during
1980-91 are as follows:
➢ Argentina- 416.9%
➢ Brazil- 327.6%
➢ Mexico- 66.5%
➢ Peru- 287.3%
➢ Yugoslavia- 123%

1. Hyper Inflation:

Hyper inflation takes place when prices shoot up at more than

three digit rate per annum. During the period of hyper inflation, paper
currency becomes worthless. Germany had hyper inflation in 1922 and
1923 when wholesale price index shot up by ‘100 million percent between
December 1922 and November 1923. In recent times, Argentina, Brazil
and Peru had hyper inflation in 1989 and 1991 as shown below:
 Country 1989 1990
Argentina 3079.8% 2314.0%
Brazil 1287.0% 2937.8%
Peru 3398.6% 7481.7%

CAUSES OF INFLATION

1. Demand-pull inflation.

According to the demand pull theory price rise in response to

an excess of aggregate demand over existing supply of goods and
services. The demand pull theorists point out that inflation might be
caused, in the first place, by an increase in the quantity of money,
when the economy is operating at full employment level. As the
quantity of money increases, the rate of interest will fall and,
consequently, investment will increase. This increased investment
expenditure will soon increase the income of the various factors of
production. As a result, aggregate consumption expenditure will
increase leading to an effective increase in the effective demand. With
the economy already operating at the level of full employment, this
will immediately raise prices, and inflationary forces may emerge.

2. Cost-push inflation
A group of economists holds the opposite view that the process
of inflation is initiated not by an excess of general demand but by an
increase in costs, as factors of production try to increase their share of
total product by raising their prices. Thus, it has been viewed that a
rise in prices is initiated by growing cost factors. Therefore, such a
price is termed as “cost push inflation” as prices are being pushed up
by the rising factor cost.
Cost push inflation is induced by wage inflation process. It is
believed that wages constitute nearly seventy percent of the total cost
of production.
This is specially true for a country like India, where labour
intensive techniques are commonly used. Thus rise in wages leads to a
rise in the total cost of production and a consequent rise in the price
level, because fundamentally, prices are based on costs. Any
autonomous increase in costs, such as rise in price of imported
components or an increase in indirect taxes (excise duties, etc), may
initiate a cist push inflation.
MEASURES TO CONTROL INFLATION
1. Monetary Policy set by RBI

• CRR (Cash Reserve Ratio): Currently 5.50%.

A cash reserve ratio (or CRR) is the percentage of bank

reserves to deposits and notes. The cash reserve ratio is also
known as the cash asset ratio or liquidity ratio. India's central
bank ordered commercial banks to hold a larger share of deposits
in cash, and raised a key short-term lending rate in a bid to curb
high inflation that has stoked fears of overheating.

• SLR (Statutory Liquidity Ratio): Currently 24%

Statutory Liquidity Ratio (SLR) is a term used in the

regulation of banking in India. It is the amount which a bank has
to maintain in the form of cash, gold or approved securities. The
quantum is specified as some percentage of the total demand and
time liabilities ( i.e. the liabilities of the bank which are payable on
demand anytime, and those liabilities which are accruing in one
months time due to maturity) of a bank. This percentage is fixed
by the Reserve Bank of India. The maximum and minimum limits
for the SLR are 40% and 25% respectively.

• Repo rate: Current 7.50%

Whenever the banks have any shortage of funds they can

borrow it from RBI. Repo rate is the rate at which our banks
borrow rupees from RBI. A reduction in the Repo rate will help
banks to get money at a cheaper rate. When the Repo rate
increases borrowing from RBI becomes more expensive.

• Reverse Repo rate: Current 6.00%

Reverse Repo rate is the rate at which Reserve Bank of India

(RBI) borrows money from banks. Banks are always happy to
lend money to RBI since their money is in safe hands with a good
interest. An increase in Reverse repo rate can cause the banks to
transfer more funds to RBI due to these attractive interest rates. It
can cause the money to be drawn out of the banking system. Due
to this fine tuning of RBI using its tools of CRR, Bank Rate, Repo
Rate and Reverse Repo rate our banks adjust their lending or
investment rates for common man.

1. Fiscal Policy set by GOVERNMENT OF INDIA

 • TAXATION

Government to ease liquidity may change the tax rate

structure. An increase in tax rate may suppress the cash flow
in the economy. Taxes like excise duties, octroi rate, income tax
rate or the corporate tax.

• GOVERNMENT EXPENDITURE

Expenditure on public welfare schemes like infrastructure

schemes like construction of roads, power generation plants,
construction of dams etc. If more expenditure is on public
welfare there is a possibility of rising inflation. Thus for
curbing inflation lesser expenditure projects is a measure.

• PUBLIC BORROWINGS

A public borrowing is the money taken by the government

from the people on which the government pays them interest.
The money which is borrowed is used for public expenditure.
The reason behind public borrowings is to stop /restrict the
cash influx in the economy. More the public borrowings, the
less influx of money in the economy so less the inflation and
vice versa.

Top 10 nations with highest inflation (As on May 19,2008).

1. Zimbabwe: 355,000%
The inflation in Zimbabwe for the month of March 2008 rose to 355,000%! Yes,
355,000 per cent! It more than doubled from the February figure of 165,000%.
Economists say that it is a miracle that the Zimbabwean economy is still surviving
and prices have been rising to unprecedented proportions. Inflation surged between
February and March following the sudden rise in money supply that flooded the
economy to finance the 2008 elections. Apart from this food and non-alcoholic
beverages continued to drive up inflation.
Almost 80% of the nation is unemployed. The Zimbabwean central bank has
introduced $500 million bearer cheques (or currency notes) for the public, and $5
billion, $25 billion, $50 billion agro-cheques for farmers. Just last fortnight the
nation had introduced $250 million bearer cheques.
A sausage sandwich sells for Zimbabwean $50 million. A 15-kg bag of potatoes cost
Zimbabwean $260 million. But then, Zimbabwean $50 million is roughly equal to
US$ 1!
2. Iraq: 53.2%
War-torn Iraq is also facing a huge problem, not only on the political front but
also on the economic one. Inflation in Iraq is running amuck. It currently stands at
53.2%.
Rising oil prices, political instability, terrorism and the other post-conflict dynamics
have led to inflation in the nation rise to unmanageable proportions
Some hurried counter-by the Iraqi central bank to curb inflation too have added
fuel to the fire.

3. Guinea: 30.9%
Guinea is also one of the world's poorest countries. The inflation in the nation is at
30.9%.
Although blessed with rich mineral wealth -- with huge iron ore, gold and diamond
deposits -- Guinea has been languishing as one of the poorest nations on earth with
large-scale unemployment, lack of industry and infrastructure dogging it.

4. San Tome and Principe: 23.1%

The mainstay of the economy of San Tome and Principe, an African nation, is
agriculture. The main export from the nation is cocoa. It also exports coconut,
coffee, etc.
The current inflation rate in San Tome and Principe is at 23.1%.
The country does not produce enough to meet domestic demand and thus is forced
to import some essential commodities. With prices of food and other essential items
rising in the global markets, imports for the nation have become almost
unsustainable, leading to high prices and inflation.
The nation has undertaken myriad measure to reform the economy, but it is still
early days and the results of liberalisation will only be noticeable over a period of
time.

5. Yemen: 20.8%
Yemen is going through terrible times. The Yemini economy is experiencing an
inflation rate of 20.8%.
More than 87% of Yemenis live for less than $2 a day. About 52% of children less
than 5 years old suffer from malnutrition.
Most of the people are engaged in agriculture, followed by the services and
infrastructure sectors, while unemployment is rampant at 35 per cent.

6. Myanmar: 20%
Myanmar is one of the world's poorest nations. It has suffered immensely under
military rule for decades and has been categorised as one of the 'least developed
countries' in the world by the United Nations. Its inflation rate is at 20%.
The economy of Myanmar is mostly controlled by the military junta leaving little
room for private entrepreneurship or growth.
The military regime has also decided to do away with all reforms suggested by
economists, throwing the nation's economy into further turmoil.
7. Uzbekistan: 19.8%
Uzbekistan is slowly moving from a somewhat closed to a market-based economy.
The economic reforms have helped achieve some growth, but not nearly as much as
the nation would ideally like to enjoy.
Also, lack of infrastructure, tight state control over the economy, occasional
skirmishes with neighbouring nations, and an unstable political environment have
seen inflation rise sharply here.
The nation's inflation rate is at 19.8% currently.
8. Democratic Republic of Congo: 18.2%
Global investors do not feel that the Republic of Congo has a foreigner-friendly
investment environment as it does not offer any incentive to the investor. Added to
that a disorganized yet costly work force, high electricity costs, irregular supply of
raw material, occasional civil unrest, political instability have only added to Congo's
woes.
And even as the nation grapples with its myriad problems, the Congolese economy
has been going from bad to worse. And its current rate of inflation is 18.2%.
9. Afghanistan: 17%
Afghanistan has long been a theatre of conflict and that has affected its economy
adversely. Perpetual battles, an environment of fear, lack of infrastructure, industry
and services has led to a once-proud nation turn into one of the world's poorest. The
inflation rate in Afghanistan is at 17%.
The influx of billions of dollars of international aid has not really helped the
economy much, although it is supposed to be much better now than it was in 2002.
10. Serbia: 15.5%
Serbia's fragile economy, which mostly rests on agriculture, services and some
manufacturing activity, has been going through a reform process for a long time.
However, economic sanctions that were imposed on the nations in the 1990s have hit
Serbia's economy so hard that its myriad economic problems continue to this day.
Unemployment is rampant, foreign investment is down to a trickle, foreign
exchange reserves are low, and political instability are keeping good projects from
taking off.
Although the nation is growing at a robust pace, the rising inflation -- currently at
15.5% -- is hurting the Serbian economy.