introduction : introduction Inflation Inflation : Inflation This is the process by which the price level rises and money loses value.
There are two kinds of inflation:
a) Demand pull
b) Cost push Demand pull inflation : Demand pull inflation Demand pull inflation may be due to :
Increase in money supply
Increase in government purchases
Increase in exports Cost push Inflation : Cost push Inflation Cost push inflation may arise because of :
Increase in money wage rates
Increase in money prices of raw materials. Hyper inflation : Hyper inflation Extremely rapid or out of control inflation.
There is no precise numerical definition to hyperinflation.
Price increases are so out of control that the concept of inflation is meaningless.
The most famous example of hyperinflation occurred in Germany between January 1922 and November 1923.
By some estimates, the average price level increased by a factor of 20 billion! Money and Prices During Hyperinflations : Money and Prices During Hyperinflations Copyright © 2004 South-Western (a) Austria (b) Hungary Money supply Price level Index (Jan. 1921 = 100) Index (July 1921 = 100) Price level 100,000 10,000 1,000 100 1925 1924 1923 1922 1921 Money supply 100,000 10,000 1,000 100 1925 1924 1923 1922 1921 Stagflation : Stagflation A condition of slow economic growth and relatively high unemployment accompanied by inflation.
This happened to a great extent during the 1970s, when world oil prices rose dramatically, fueling sharp inflation in developed countries.
At least some central banks have expressed concern over inflation even as the global economy seems to be slowing down. Money Supply, Money Demand, and the Equilibrium Price Level : Money Supply, Money Demand, and the Equilibrium Price Level Copyright © 2004 South-Western Quantity of Money Value of Money, 1 / P Price Level, P 0 1 (Low) (High) (High) (Low) 1 / 2 1 / 4 3 / 4 1 1.33 2 4 The Effects of Excess Money Supply : The Effects of Excess Money Supply Copyright © 2004 South-Western Quantity of Money Value of Money, 1 / P Price Level, P 0 1 (Low) (High) (High) (Low) 1 / 2 1 / 4 3 / 4 1 1.33 2 4 How is inflation measured? : How is inflation measured? WPI (Wholesale Price Index)
India- the only major country that uses WPI (1st published in 1902)
What is WPI?
The WPI number is a weekly measure of wholesale price movement for the economy WPI- The Indian Example : WPI- The Indian Example Indian government constructed its present WPI way back in 1993-94 (1993-94 series replacing 1981-82 bases) by making a basket of 435 commodities
Laspeyres formula employed
The 100-point index is subdivided into three groups Slide 12: Major Groups:
I. Primary Articles (98 items)- 22.02 %
Food Articles, Non-Food Articles, Minerals
II. Fuel, Power, Light & Lubricants (19 items)
- 14.23 %
III. Manufactured Products (318 items)
- 63.75 %
Beverages, Tobacco & Tobacco Products
Textiles… etc Slide 13: The Office of the Economic Advisor (OEA) compile the WPI numbers on weekly basis
On Friday inflation figures are announced
The working group on WPI, headed by Planning Commission member Abhijit Sen, has worked out a new index
The base year of the new index :2000-01
The basket of commodities- around 1200
To Reflect the post-liberalisation consumption pattern Consumer Price Index (CPI) : Consumer Price Index (CPI) A measure of the average price of consumer goods and services purchased by households (1st published in 1970)
CPI indicates the change in the purchasing power of the consumer
CPI for Industrial Workers (CPI-IW),
CPI for Agricultural Labourers / Rural Labourers (CPI -AL/RL),
CPI for Urban Non-Manual Employees (CPI-UNME)
Published on a monthly basis Slide 15: Producer Price Index (PPI)
Measures average changes in prices received by domestic producers for their output
Service Price Index (SPI)
The share of the service sector in the (GDP) gone up from 28% (1950) to over 50%
Necessitates representation of Services in the price index Discussion question : Discussion question Why is inflation bad? Slide 17: Unanticipated inflation is bad because it makes the economy behave like a giant casino.
Gains and losses occur because of unpredictable changes in the value of money.
If the value of money varies unpredictably over time, the quantity of goods and services that money will buy will also fluctuate unpredictably.
Resources are also diverted from productive activities to forecasting inflation.
Unanticipated inflation leads to :
Redistribution of income, borrowers and lenders
Too much or too little lending or borrowing The Economic Impacts of Inflation : The Economic Impacts of Inflation Redistribution of Income and wealth among different groups
Distortion in relative prices and outputs of different goods, or sometimes in output and employment for the economy as a whole. THE COSTS OF INFLATION : THE COSTS OF INFLATION Shoe leather costs
Confusion and inconvenience
Arbitrary redistribution of wealth Shoe leather costs : Shoe leather costs Shoe leather costs are the resources wasted when inflation encourages people to reduce their money holdings.
Inflation reduces the real value of money, so people have an incentive to minimize their cash holdings.
Less cash requires more frequent trips to the bank to withdraw money from interest-bearing accounts. Menu costs : Menu costs Menu costs are the costs of adjusting prices.
During inflationary times, it is necessary to update price lists and other posted prices.
This is a resource-consuming process that takes away from other productive activities. Inflation-Induced Tax Distortion : Inflation-Induced Tax Distortion The income tax treats the nominal interest earned on savings as income, even though part of the nominal interest rate merely compensates for inflation.
The after-tax real interest rate falls, making saving less attractive. Taming Inflation : Taming Inflation Monetary policy- Bank rate policies, Open Market operations, Reserve requirement ratios
Fiscal policy-taxation, public borrowing, public expenditure
Direct Control-Fixing ceiling prices of the products, Rationing.
Wages, Controlling population growth The Effects of Monetary Injection : The Effects of Monetary Injection Copyright © 2004 South-Western Quantity of Money Value of Money, 1 / P Price Level, P 0 1 (Low) (High) (High) (Low) 1 / 2 1 / 4 3 / 4 1 1.33 2 4 Slide 25: We are open for Queries???