So here goes my next piece of information to all my dear friends : INFLATION! Yes! Isn’t Inflation one of the major issues in India ? How about a brief overview on Inflation? Let’s see. 🙂
Inflation leads to lowering of purchasing power, which can in turn lead to a slowing or stagnant economy. Inflation reduces savings, pushes up interest rates, dampens investments, leads to depreciation of currency then makes imports costlier.
- The Money Supply : The value of money is determined by the amount of currency that is in circulation and the public’s perception of the value of that money. If government and RBI decides to put more money into the circulation at a rate higher than the economy’s growth rate, the value of money falls down and in turn result in the rise of prices of goods and services. To put it in simple words, “The rarer a specific item is, the more valuable it is”.
- The National Debt : As a country’s debt increases, the government has two options: they can either raise taxes or print more money to pay off the debt. A rise in taxes will cause businesses to raise their prices to offset the increased corporate tax rate. Printing more money will lead to devaluation of currency as discussed above.
- Demand-Pull Effect : This theory states that when the demand is more than the supply of products, producers tend to raise the prices to the level the consumer will bear in order to balance supply and demand.
- Cost-Push Effect : This theory states that when companies are faced with increased input costs like raw goods and materials or wages, they will preserve their profitability by passing this increased cost of production onto the consumer in the form of higher prices.
- External Factors : When the exchange rate suffers such that the Indian currency has become less valuable relative to foreign currency, this makes foreign commodities and goods more expensive to Indian consumers while simultaneously making Indian goods, services, and exports cheaper to consumers overseas. The money spent by government for the civil wars is also one of the reasons for inflation.
- Due to economic crisis in other parts of world, India’s export has contracted significantly which has resulted in adverse Balance of Payment conditions.
How to Control Inflation ?
- Monetary Policy : This is the process by which RBI controls the supply of money into the economy, often targeting ‘rate of interest’ that is, the price at which money can be borrowed. Higher interest discourages the borrowing of money from the banks and hence reducing the flow of money in the economy.
- Fiscal Policy : This policy is the tool used by the government revenue collection (taxation) and expenditure (spending) to influence aggregate demand and the level of economic activity. Economists suggest that increasing government spending and decreasing taxes are the best ways to stimulate growth. This method was used by the government during 2008 recession as an essential for building.
- Fixed Exchange Rates : Under this regime, a country’s currency is tied in value to another single currency or sometimes measure of values such as gold. As the value of the reference currency rises and falls, so does the currency pegged to it. Measures have to be taken to avoid devaluation of the currency.
- Administrative policies or Direct wage Controls : Setting restrictions on the growth rate of wages may decrease Cost-Push inflation.
Supply Side Reform Policy : If more output is produced at a low per unit cost, there are chances for the economy to attain persistent economic growth and development, without being affected by inflation.
- Government steps should boost export-intensive sectors and develop import-substituting industries in order to make India less dependent on imports.
Government should create a stable political and economic environment in order to make India an attractive destination for foreign investments.
- Government should increase the limit of FDI (Foreign direct investment) in the existing sectors as well as encouraging other sectors such as aviation, retail, telecommunication, radio & broadcasting etc.
Small amount of Inflation can be a good thing??? :O
In fact it is surprising to most people, economists generally argue that small inflation is a good thing. A healthy rate of inflation is considered to be approximately 2-3% per year.
A healthy rate of inflation is considered as positive because it results in increasing wages and corporate profitability and keeps capital flowing in a growing economy. Increased wages encourages consumption which can in turn further stimulate the economy and create more jobs. For example, if you wanted to buy a specific item, and knew that the price of it would rise by 2-3% in a year, you would be encouraged to buy it now. Don’t you think? It further helps the economy keep off deflation which can otherwise set off a recession. Inflation at a moderate level is an incentive to the producer.
Mild Inflation is seen as “Greasing the wheels of commerce”
There are many more points if we continue on Inflation. The control of Inflation cannot be done over night. The monetary policy makers and the Government has to analyse the global economic conditions and handle the situation wisely.
The future of Indian economy depends on how our policy makers deal with Inflation.
The current government has already taken measures to come out of Inflation and I hope eventually the problem will be solved. If I have missed any point I kindly request you to post it in the comments below!
Thanks to – http://en.wikipedia.org/wiki/Inflation