INFLATION

BACHELOR IN ACCOUNTING & FINANCE

(2012-2013)

PROJECT GUIDE: Prof. SAYLI MAM SUBMITTED BY POOJA CHAUHAN 216

CHIKITSAK SAMUHAS S.S. & L.S. PATKAR COLLEGE OF ARTS & SCIENCE AND V.P. VARDE COLLEGE OF COMMERCE &ECONOMICS S.V ROAD, GOREGAON (WEST), MUMBAI 400 062. Cover (black colour gold font)

INFLATION

BACHELOR IN ACCOUNTING & FINANCE (2012-2013)

Submitted In Partial Fulfillment of the Requirements For the Award of Degree of Bachelor in Accounting & Finance BY POOJA CHAUHAN 216

CHIKITSAK SAMUHAS S.S. & L.S. PATKAR COLLEGE OF ARTS & SCIENCE AND V.P. VARDE COLLEGE OF COMMERCE & ECONOMICS S.V ROAD, GOREGAON (WEST), MUMBAI 400 062.

CHIKITSAK SAMUHAS S.S. & L.S. PATKAR COLLEGE OF ARTS & SCIENCE AND V.P. VARDE COLLEGE OF COMMERCE & ECONOMICS S.V ROAD, GOREGAON (WEST), MUMBAI 400 062.

CERTIFICATE This is to certify that Ms. POOJA CHAUHAN Of Bachelor in Accounting & Finance Semester V (2012-2013) has successfully completed the project on under the guidance of Prof. Mrs. SAYLI MAM.

Course Co-ordinator

Principal

Project Guide/ Internal Examiner

External Examiner

DECLARATION

I POOJA CHAUHAN the student of Bachelor in Accounting & Finance Semester V (2012 -2013) hereby declares that I have completed the project on INFLATION. The information submitted is true and original to the best of my Knowledge.

Signature

POOJA CHAUHAN 216

ACKNOWLEDGEMENT

Success is an effort bounded activity that involves co-operation of all. I hereby take the opportunity to express my profound sense of gratitude and reverence to all those who have helped and encouraged me towards successful completion of the Project Report. It has been a great experience working on the project INFLATION.

I express my sincere thanks to my all B.A.F faculty, for guiding me right form the inception till the successful completion of the project. I sincerely acknowledge them for extending their valuable guidance, support for literature Mrs.Sayli Mam, critical reviews of project and the report and above all the moral support she had provided to me with all stages of this project. This project has helped me to learn the intricacies of restructuring and Im grateful to them for making this learning possible.

Last but not the least I would like to thank each and every one who has Helped me in learning process, my gratitude to great almighty and my parents without whose concerned and devoted support the project would not have been the way it is today.

INFLATION

EXECUTIVE SUMMARY

Inflation is a situation of sustained and inordinate increase in the prices of goods and services. Read on to understand the various types of inflation.

One of the economic effects of inflation is the change in the marginal cost of producing money. This involves the appropriate 'price' of money which, in this case, is the nominal rate of interest. This 'price' indicates the return which has to be pre-determined to hold back the printing presses, in place of some other assets which offer the market interest rate.

In addition, if a country has a higher rate of inflation than other countries, its balance of trade is likely to move in an unfavorable direction. This is because there is a decline in its price competitiveness in the global market.

According to the 2008 Economic Survey Report, Indias inflation rate was targeted by the Reserve Bank of India (RBI) to be 4.1%, down from a rate of 5.77% in 2007. Inflation rates for many investment goods have decreased dramatically in recent years.

Table of Contents

1. 2. 3. 4. 5. 6. 7. 8. 9.

Introduction of Inflation...1 Causes of Inflation.3 How Inflation Is Measured......10 Problems of inflation....12 Inflation & Interest Rate..15 Effects of inflation....17 Measures to Control Inflation.23 Other Monetary phenomena......31 Type of inflation...34 10. Inflation in India.43 11. RBIS Credit Policy Review: Growth VS Inflation.55 Conclusion.......59 13. Bibliography...61

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INTRODUCTION OF INFLATION

Inflation is when prices continue to creep upward, usually as a result of overheated economic growth or too much capital in the market chasing too few opportunities. Usually wages creep upwards, also, so that companies can retain good workers. Unfortunately, the wages creep upwards more slowly than do the prices, so that your standard of living can actually decrease.. How Does Inflation Impact our Life? Inflation hurts your standard of living because you have to pay more and more for the same goods and services. If your income doesn't increase at the same rate as inflation, you will find your standard of living declining even though you are making more. Also, inflation doesn't impact everything equally, so that some things (such as gas prices) can double while other things (your home) may lose value. For this reason, it makes financial planning more difficult. Inflation is really bad for your retirement planning because your target will have to keep getting higher and higher to pay for the same quality of life. In other words, your savings will buy less and less, so you will need to save more and more. Inflation and the economy of a country are closely related. The effect on the economy of any country is not immediate or it does not affect the economy overnight. There is a cumulative effect. 1

Several such changes build up to bring about a big change. The economy of a country is affected by inflation in a number of ways. Inflation and the economy both influence all the major macroeconomic indicators of a country. The various macroeconomic indicators include the following:

Gross domestic product or GDP Producer price index (industrial) Consumer price indices Industrial production Capital Investment Agricultural production Export Import Demography Debt

Inflation not only affects the macroeconomic indicators, it affects the living standards of the people. As the percentage of inflation increases, the cost of all commodities also increases. This in turn influences trade. When exchange rates are affected, the interest rates cannot be far behind. Inflation and its effect on economy may be of two types:

Expected inflation Unexpected inflation 2

CAUSES OF INFLATION
A sustained rise in the prices of commodities that leads to a fall in the purchasing power of a nation is called inflation. Although inflation is part of the normal economic phenomena of any country, any increase in inflation above a predetermined level is a cause of concern. The basic causes of inflation were covered at AS level. This note considers the demand and supply-side courses in more detail including the impact of changes in the exchange rate and the prices of goods and services in the international economy. Cost Push Inflation:Cost-push inflation occurs when businesses respond to rising production costs, by raising prices in order to maintain their profit margins. There are many reasons why costs might rise: Rising imported raw materials costs perhaps caused by inflation in countries that are heavily dependent on exports of these commodities or alternatively by a fall in the value of the pound in the foreign exchange markets which increases the UK price of imported inputs. A good example of cost push inflation was the decision by British Gas and other energy suppliers to raise substantially the prices for gas and electricity that it charges to domestic and industrial consumers at various points during 2005 and 2006.

Rising labour costs - caused by wage increases which exceed any improvement in productivity. 3

This cause is important in those industries which are labour-intensive. Firms may decide not to pass these higher costs onto their customers (they may be able to achieve some cost savings in other areas of the business) but in the long run, wage inflation tends to move closely with price inflation because there are limits to the extent to which any business can absorb higher wage expenses.

Higher indirect taxes imposed by the government for example a rise in the rate of excise duty on alcohol and cigarettes, an increase in fuel duties or perhaps a rise in the standard rate of Value Added Tax or an extension to the range of products to which VAT is applied. These taxes are levied on producers (suppliers) who, depending on the price elasticity of demand and supply for their products, can opt to pass on the burden of the tax onto consumers. For example, if the government was to choose to levy a new tax on aviation fuel, then this would contribute to a rise in cost-push inflation. Cost-push inflation can be illustrated by an inward shift of the short run aggregate supply curve. This is shown in the diagram below. Ceteris paribus, a fall in SRAS causes a contraction of real national output together with a rise in the general level of 4

Prices

Demand Pull Inflation:Demand-pull inflation is likely when there is full employment of resources and when SRAS is inelastic. In these circumstances an increase in AD will lead to an increase in prices. AD might rise for a number of reasons some of which occur together at the same moment of the economic cycle

A depreciation of the exchange rate, which has the effect of increasing the price of imports and reduces the foreign price of UK exports. If consumers buy fewer imports, while foreigners buy more exports, AD will rise. If the economy is already at full employment, prices are pulled upwards. 5

A reduction in direct or indirect taxation. If direct taxes are reduced consumers have more real disposable income causing demand to rise. A reduction in indirect taxes will mean that a given amount of income will now buy a greater real volume of goods and services. Both factors can take aggregate demand and real GDP higher and beyond potential GDP.

The rapid growth of the money supply perhaps as a consequence of increased bank and building society borrowing if interest rates are low. Monetarist economists believe that the root causes of inflation are monetary in particular when the monetary authorities permit an excessive growth of the supply of money in circulation beyond that needed to finance the volume of transactions produced in the economy.

Rising consumer confidence and an increase in the rate of growth of house prices both of which would lead to an increase in total household demand for goods and services.

The effects of an increase in AD on the price level can be shown in the next two diagrams. Higher prices following an increase in demand lead to higher output and profits for those businesses where demand is growing. The impact on prices is greatest when SRAS is inelastic.

The wage price spiral expectations-induced inflation Rising expectations of inflation can often be self-fulfilling. If people expect prices to continue rising, they are unlikely to accept pay rises less than their expected inflation rate because they want to protect the real purchasing power of their incomes. For example a booming economy might see a rise in inflation from 3% to 5% due to an excess of AD. Workers will seek to negotiate higher wages and there is then a danger that this will trigger a wage-price spiral that then requires the introduction of deflationary policies such as higher interest rates or an increase in direct taxation.

Inflation influences in the British economy

Average earnings comprise basic pay + income from overtime payments, productivity bonuses, profit-related pay and other supplements to earned income

Productivity measures output per person employed, or output per person hour. A rise in productivity helps to keep unit costs down. However, if earnings to people in work are rising faster than productivity, then unit labour costs will increase The growth of unit labour costs is a key determinant of inflation in the medium term. Additional pressure on prices comes from higher import prices, commodity prices (e.g. oil, copper and aluminum. Prices also increase when businesses decide to increase their profit margins. They are more likely to do this during the upswing phase of the economic cycle.

HOW INFLATION IS MEASURED?

Inflation is normally given as a percentage and generally in years or 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 is measured 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 on the CPI. You will also often hear about the "Core Rate" or the "Core CPI." There are certain items in the bundle used to measure the CPI that are extremely volatile, such as gasoline prices. By eliminating the items that can significantly affect the cost of the bundle (in either direction) on a month-tomonth basis, the Core rate 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 the PPI. 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.

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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 is sold to a consumer. The PPI actually combines a series of

smaller indices that cross many industries and measure the prices for three types of goods: crude, intermediate and finished. Generally, the markets are most concerned with the finished goods because these are a strong indicator of what will happen with future CPI reports. The CPI is a more popular measure of inflation than the PPI, but investors watch both closely.

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PROBLEMS OF INFLATION
Prices increase therefore people may buy fewer goods, the economy may suffer

 People need to keep asking for pay increases to match price rises. This can cause problems at work If people are on fixed incomes e.g. pensioners or students. They will be worse off because they will be able to buy fewer goods The costs to businesses may increase. They may cutback on production. If the prices of UK goods increase too much then people and businesses may start to import more goods from abroad because they are cheaper. This will cause major problems for the economy. Inflation and the housing market Inflation in the housing market due to demand pull inflation Notting Hill is a very popular district of London. In 1999 the average house sold for a price of 200,000. This was satisfactory to both buyers and sellers of houses.

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However in the year 2000 houses suddenly became far more popular in Notting Hill. This was due to a number of reasons popularity of the area due to Hugh Grants film feel good factor and consumer confidence income tax cuts meant that people had more money to spend lower interest rates meant that mortgage repayments were lower

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INFLATION, ECONOMIC INFLATION

Inflation means a persistent rise in the price levels of commodities and services, leading to a fall in the currencys purchasing power. The problem of inflation used to be confined to national boundaries, and was caused by domestic money supply and price rises. In this era of globalization, the effect of economic inflation crosses borders and percolates to both developing and developed nations. Central bankers believe that mild inflation, in the 1 to 2 per cent range, is the most benign for a countrys economy. High inflation, stagflation or deflations are all considered to be serious economic threats.
CAUSES OF ECONOMIC INFLATION

The following factors can lead to inflation: Printing too much money. This is called a loose or expansionary monetary policy. If there is a lot of money going around, then supply is plentiful compared to the products you can buy with that money. The law of supply and demand therefore dictates that prices will rise. Increases in production costs.

Tax rises. Declines in exchange rates. Decreases in the availability of limited resources such as food or oil. War or other events causing instability. Economists generally believe that money supply is the key cause of inflation; in 2008, however, skyrocketing prices of oil, food and steel caused runaway levels of inflation in the world economy that collapsed only because of the global Financial Crisis. 14

INFLATION & INTEREST RATE

Interest and inflation are key to investing decisions, since they have a direct impact on the investment yield. When prices rise, the same unit of a currency is able to buy less. A sustained deterioration in the purchasing power of money is called inflation. Investors aim to preserve the value of their money by opting for investments that generate yields higher than the rate of inflation. In most developed economies, banks try to keep the interest rates on savings accounts equal to the inflation rate. However, when the inflation rate rises, companies or governments issuing debt instruments would need to lure investors with a higher interest rate. The Relationship between Interest and Inflation Inflation is an autonomous occurrence that is impacted by money supply in an economy. Central governments use the interest rate to control money supply and, consequently, the inflation rate. When interest rates are high, it becomes more expensive to borrow money and savings become attractive. When interest rates are low, banks are able to lend more, resulting in an increased supply of money. Alteration in the rate of interest can be used to control inflation by controlling the supply of money in the following ways: A high interest rate influences spending patterns and shifts consumers and businesses from borrowing to saving mode. This influences money supply. A rise in interest rates boosts the return on savings in building societies and banks. Low interest rates encourage investments in shares. Thus, the rate of interest can impact the holding of particular assets. A rise in the interest rate in a particular country fuels the inflow of funds. Investors with funds in other countries now see investment in this country as a more profitable option than before.

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Inflation and Interest Rates: Effect on the Time Value of Money Inflation has a significant impact on the time value of money (TVM). Changes in the inflation rate (whether anticipated or actual) result in changes in the rates of interest. Banks and companies anticipate the erosion of the value of money due to inflation over the term of the debt instruments they offer. To compensate for this loss, they increase the interest rates. The central bank of a country alters interest rates with the broader purpose of stabilizing the national economy. Investors need to keep a close watch on interest and inflation to ensure that the value of their money increases over time.

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EFFECTS OF INFLATION

One of the economic effects of inflation is the change in the marginal cost of producing money. This involves the appropriate 'price' of money which, in this case, is the nominal rate of interest. This 'price' indicates the return which has to be pre-determined to hold back the printing presses, in place of some other assets which offer the market interest rate. In addition, if a country has a higher rate of inflation than other countries, its balance of trade is likely to move in an unfavorable direction. This is because there is a decline in its price competitiveness in the global market. A high rate of inflation can cause the following economic impediments:

The values of investments are destroyed over time. It is economically disastrous for lenders. Arbitrary governmental control of the economy to control inflation can restrain economic development of the country.

Inflation and economic growth are incompatible because the former affects all sectors as indicated by: CPI or Consumer Price Index A rise in the CPI indicates inflation. The CPI or the consumer price index is used as an index for salaries, wages, contracted prices, pensions. This is done to adjust with the inflation effects. It is an important economic indicator.

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GDP or Gross Domestic Product The gross domestic product is another important economic indicator and is usually inflation adjusted. This is an important tool for measuring the rate of inflation. The important segments, which are hampered include: Investment Interest rates Exchange rates Unemployment Stocks Various monetary policies Various fiscal policies The effect of inflation and economic growth is manifested in the following cases: I) Investment: If the prices of goods increases and people have to compensate for the increase in price, they usually make use of their savings. In the event when savings are depleted, fund for investment is no longer available. An individual tends to invest, only if savings of an individual is strong and has sufficient money to meet his daily needs. II) Interest rates: Whenever inflation reigns supreme, it is a well known fact that the value of money goes down. This leads to decline in the purchasing power. In the event, when the rate of inflation is high, the interest rates also rise. With increase in both parameters, cost of goods will not remain the same and consequently people will have to shell out more money for the same goods. III) Exchange rates: Inflation and economic growth are affected by exchange rates as well. Exchange rates denote the value of money prevailing in different countries. High rate of inflation causes severe fluctuations in exchange rates. This adversely affects trade (export and import), important business transaction across borders and value of money also changes.

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IV) Unemployment: Growth of a nation depends to a large extent on employment. If rate of inflation is high, unemployment rate is low and vice versa. This theory is propounded by economist William Philips and this gave rise to the Philips Curve. V) Stocks: The returns a company offer, on investment fully depend on the performance of the company. Past performance, current position of the company and future trends decide how much(money, in form of bonus or dividend) is to be returned to the investors. Owing to inflation, several monetary as well as fiscal policies are impacted. Inflation can have positive and negative effects on an economy. Negative effects of inflation include loss in stability in the real value 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 goods if consumers begin hoarding out of concern that prices will increase in the future. Positive effects include a mitigation of economic recessions, 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 effects of inflation: NEGATIVE EFFECTS ARE: Hoarding (people will try to get rid of cash before it is devalued, by hoarding food and other commodities creating shortages of the hoarded objects). Distortion of relative prices (usually the prices of goods go higher, especially the prices of commodities). Increased risk - Higher uncertainties (uncertainties in business always exist, but with inflation risks are very high, because of the instability of prices).

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 Income diffusion effect (which is basically an operation of income redistribution). Existing creditors will be hurt (because the value of the money they will receive from their borrowers later will be lower than the money they gave before). Fixed income recipients will be hurt (because while inflation increases, their income doesnt increase, and therefore their income will have less value over time). Increased consumption ratio at the early stages of inflation (people will be consuming more because money is more abundant and its value is not lowered yet). Lowers national saving (when there is a high inflation, saving money would mean watching your cash decrease in value day after day, so people tend to spend the cash on something else). Illusions of making profits (companies will think they were making profits while in reality theyre losing money if they dont take into consideration the inflation rate when calculating profits). Causes an increase in tax bracket (people will be taxed a higher percentage if their income increases following an inflation increase). Causes mal-investment (in inflation times, the data given about 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 inflation and its effects).

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 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).

"POSITIVE" EFFECTS OF INFLATION ARE:

It can benefit the inflators (those responsible for the inflation) It be benefit early and first recipients of the inflated money (because the negative effects of inflation are not there yet). It can benefit the cartels (it benefits big cartels, destroys small sellers, and can cause price control set by the cartels for their own benefits).
It might relatively benefit borrowers who will have to pay the same

amount of money they borrowed (+ fixed interests), but the inflation could be higher than the interests; therefore they 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 the 3 years. Note: Banks are aware of this problem, and when inflation rises, their interest rates might rise as well. So don't take out loans based on this information.

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 Many economists favour a low steady rate of inflation, low (as

opposed to zero or negative) inflation may reduce the severity of economic recessions by enabling the labour market to adjust more quickly in a downturn, and reducing the risk that a liquidity trap prevents monetary policy from stabilizing the economy. The task of keeping the rate of inflation low and stable is usually given to monetary authorities. Generally, these monetary authorities are the central banks that control the size of the money supply through the setting of interest rates, through open market operations, and through the setting of banking reserve requirements. Tobin effect argues that: a moderate level of inflation can increase 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. The first three effects are only positive to a few elite, and therefore might not be considered positive by the general public.

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MEASURES TO CONTROL INFLATION

A high inflation rate is undesirable because it has negative consequences. However, the remedy for such inflation depends on the cause. Therefore, government must diagnose its causes 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 full employment, increase in total expenditures will be reflected in a general rise in prices, that is, inflation. Monetary policy is used to control inflation and is based on the assumption that a rise in prices is due to excess of monetary demand for goods and services by the consumers/households e because easy bank credit is available to them. Monetary policy, thus, pertains to banking and credit availability of loans to firms and households, interest rates, public debt and its management, and the monetary standard. Monetary management is aimed at the commercial banking 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 credit in the economy, thereby influencing the structure of interest rates and the availability of credit. Both these, factors affect the components of aggregate demand and the flow of expenditure in the economy. 23

The central banks monetary management methods, the devices for decreasing or increasing the supply of money and credit for monetary stability is called monetary policy. Central banks generally use the three quantitative measures to control the volume 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 central banks and, to that extent, monetary measures to control inflation are 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 economic system 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 speculative activities, and diversifying the flow of credit towards the most desirable needs of productive and growth-inducing sector.

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It should be noted that the impression that the rate of spending can be controlled rigorously by the contraction of credit or money supply is wrong in the context of modern economic societies. In modern community, tangible, wealth is typically represented by claims in the form of securities, bonds, etc., or near moneys, as they are called. Such near moneys are highly liquid assets, and they are very close to being money. They increase the general liquidity of the economy. In these circumstances, it is not so simple to control the rate of spending or total outlays merely by controlling the quantity of money. Thus, there is no immediate and 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, in conjunction with other measures, play a useful role in controlling inflation. FISCAL MEASURES Fiscal policy is another type of budgetary policy in relation to taxation, public borrowing, and public expenditure. To curve the effects of inflation and changes in the total expenditure, fiscal measures would have to be implemented which involves an increase in taxation and decrease in government spending. During inflationary periods the government is supposed to counteract an increase in private spending. It can be cleared noted that during a period of full employment inflation, the aggregate demand in relation to the limited supply of goods and services is reduced to the extent that government expenditures are shortened. 25

Along with public expenditure, governments must simultaneously increase taxes that would effectively reduce private expenditure, in an effect to minimize inflationary pressures. It is known that when more taxes are imposed, the size of the disposable income diminishes, also the magnitude of the inflationary gap in regards to the availability of the supply of goods and services. In some instances, tax policy has been directed towards 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, some economists point out that this is not a correct way of combating inflation 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 in taxes produces a cash surplus in the budget. Keynes, however, suggested a programme of compulsory savings, such as deferred pay as an antiinflationary measure. Deferred pay indicates that the consumer defers a part of his or her wages by buying savings bonds (which, of course, is a sort of public borrowing), which are redeemable after a particular period of time, this is sometimes called forced savings. 26

Additionally, private savings have a strong disinflationary effect on the economy and an increase in these is an important measure for controlling inflation. Government policy should therefore, include devices for increasing savings. A strong savings drive reduces the spendable income of the consumers, without any harmful effects of 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 the deficit through public borrowings. It should be noted that it is only government borrowing from non-bank lenders that has a disinflationary effect. In addition, public debt may be managed in such a way that the supply of money in the country may be controlled. The government should avoid paying back any of its past loans during inflationary periods, in order to prevent an increase in the circulation of money. Anti-inflationary debt management also includes cancellation of public debt held by the central bank out of a budgetary surplus. Fiscal policy by itself may not be very effective in combating inflation; therefore a combination of fiscal and monetary tools can work together in achieving the desired outcome. DIRECT MEASURES OF CONTROL Direct controls refer to the regulatory measures undertaken to convert an open inflation into a repressed one. 27

Such regulatory measures involve the use of direct control on prices and rationing of scarce goods. The function of price control is a fix a legal ceiling, beyond which prices of particular goods may not increase. When ceiling prices are fixed and enforced, it means prices are not allowed to rise further and so, inflation is suppressed. Under price control, producers cannot raise the price beyond a specified level, even though there may be a pressure of excessive demand forcing it up. For example, during wartimes, price control was used to suppress inflation. In times of the severe scarcity of certain goods, particularly, food grains, government may have to enforce rationing, along with price control. The main function of rationing is to divert consumption from those commodities whose supply needs to be restricted for some special reasons; such as, to make the commodity more available to a larger number of households. Therefore, rationing becomes essential when necessities, such as food 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. Another control measure that was suggested is the control of wages as it often becomes necessary in order to stop a wage-price spiral. During galloping inflation, it may be necessary to apply a wage-profit freeze. Ceilings on wages and profits keep down disposable income and, therefore the total effective demand for goods and services. 28

On the other hand, restrictions on imports may also help to increase supplies of essential commodities and ease the inflationary pressure. However, this is possible only to a limited extent, depending upon the balance of payments situation. Similarly, exports may also be reduced in an effort to increase the availability of the domestic supply of essential commodities so that inflation is eased. But a country with a deficit balance of payments cannot dare to cut exports and increase imports, because the remedy will be worse than the disease itself. In overpopulated countries like India, it is also essential to check the growth of the population through an effective family planning programme, because this will help in reducing the increasing pressure on the general demand for goods and services. Again, the supply of real goods should be increased by producing more. Without increasing production, inflation just cannot be controlled. Some economists have even suggested indexing in order to minimise certain ill-effects of inflation. Indexing refers to monetary corrections through periodic adjustments in money incomes of the people and in the values of financial assets such as savings deposits, which are held by them in relation to the degrees of price rise. Basically, if the annual price were to rise to 20%, the money incomes and values of financial assets are enhanced by 20%, under the system of indexing.

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Indexing also saves the government from public wrath due to severe inflation persisting over a long period. Critics, however, do not favour indexing, as it does not cure inflation but rather it encourages living with inflation. Therefore, it is a highly discretionary method. In general, monetary and fiscal controls may be used to repress excess 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.

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OTHER MONETARY PHENOMENA

In Keynes view, rising prices in all situations cannot be termed as inflation. In a condition of under-employment, when an increase in money supply and rising prices are accompanied by the expansion of output and employment, but when1here are bottlenecks in the economy, an increase in money supply may cause cost and prices to rise more than the expansion of output and employment. This may be termed as semi-inflation or reflation till the ceiling of full employment is reached. Once full employment level is reached, the entire increase in money supply is reflected simply by the rising prices - the real inflation. Incidentally, Keynes mentions the following four related terms while discussing the concept of inflation: Deflation Disinflation Reflation Stagflation DEFLATION It is a condition of falling prices accompanied by a decreasing level of employment, output and income. Deflation is just the opposite of inflation. Deflation occurs when the total expenditure of the community is not equal to the existing prices. Consequently, the supply of money decreases and as a result prices fall. 31

Deflation can also be brought about by direct contractions in spending, either in the form of a reduction in government spending, personal spending or investment spending. Deflation has often had the side effect of increasing unemployment in an economy, since the process often leads to a lower level of demand in the economy. However, each and every fall in price cannot be called deflation. The process of reversing inflation without either creating unemployment or reducing output is called disinflation and not deflation. Therefore, some perceive deflation as an underemployment phenomenon. DISINFLATION When prices are falling due to anti-inflationary measures adopted by the authorities, with no corresponding decline in the existing level of employment, output and income, the result of this is disinflation. When acute inflation burdens an economy, disinflation is implemented as a cure. Disinflation is said to take place when deliberate attempts are made to curtail expenditure of all sorts to lower 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 motivating the economy to produce. This is achieved by increasing the supply of money or in some instances reducing taxes, which is the opposite of disinflation. Governments can use economic policies such as reducing taxes, changing the supply of money or adjusting the interest rates; which in turn motivates the country to increase their output. The situation is described as semi-inflation or reflation. 32

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 is slowed by an unfavorable supply, such as an increase in the price of oil in an oil importing country, which tends to raise prices at the same time that it slows the economy by making production less profitable. In the 1970's inflation and recession occurred in different economies at the same time. Basically, what happened was that there was plenty of liquidity in the system and people were spending money as quickly as they got it because prices were going up quickly. This gave rise to the second reason for stagflation.

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TYPES OF INFLATION

Inflation is a situation of sustained and inordinate increase in the prices of goods and services. Read on to understand the various types of inflation. When there is a rise in general price level for all goods and services it is known as inflation. An inflationary movement could be because of the rise in any single price or a group of prices of related goods and services. There are four main types of inflation. The various types of inflation are briefed below. 1. Wage Inflation: Wage inflation is also called as demand-pull or excess demand inflation. This type of inflation occurs when total demand for goods and services in an economy exceeds the supply of the same. When the supply is less, the prices of these goods and services would rise, leading to a situation called as demand-pull inflation. This type of inflation affects the market economy adversely during the wartime. 2. Cost-push Inflation: As the name suggests, if there is increase in the cost of production of goods and services, there is likely to be a forceful increase in the prices of finished goods and services. For instance, a rise in the wages of laborers would raise the unit costs of production and this would lead to rise in prices for the related end product. This type of inflation may or may not occur in conjunction with demand-pull inflation. 34

3. Pricing Power Inflation: Pricing power inflation is more often called as administered price inflation. This type of inflation occurs when the business houses and industries decide to increase the price of their respective goods and services to increase their profit margins. A point noteworthy is pricing power inflation does not occur at the time of financial crises and economic depression, or when there is a downturn in the economy. This type of inflation is also called as oligopolistic inflation because oligopolies have the power of pricing their goods and services. 4. Sectoral Inflation: This is the fourth major type of inflation. The sectoral inflation takes place when there is an increase in the price of the goods and services produced by a certain sector of industries. For instance, an increase in the cost of crude oil would directly affect all the other sectors, which are directly related to the oil industry. Thus, the ever-increasing price of fuel has become an important issue related to the economy all over the world. Take the example of aviation industry. When the price of oil increases, the ticket fares would also go up. This would lead to a widespread inflation throughout the economy, even though it had originated in one basic sector. If this situation occurs when there is a recession in the economy, there would be layoffs and it would adversely affect the work force and the economy in turn.

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Other Types of Inflation Fiscal Inflation: Fiscal Inflation occurs when there is excess government spending. This occurs when there is a deficit budget. For instance, Fiscal inflation originated in the US in 1960s at the time President Lydon Baines Johnson. America is also facing fiscal type of inflation under the presidentship of George W. Bush due to excess spending in the defense sector. Hyperinflation: Hyperinflation is also known as runaway inflation or galloping inflation. This type of inflation occurs during or soon after a war. This can usually lead to the complete breakdown of a countrys monetary system. However, this type of inflation is short-lived. when the inflation rate rises to over 20% it is generally considered as hyper inflation and at this stage it is almost uncontrollable because it increases more rapidly in such a little time frame. The main difference between the galloping and hyper inflation, is that hyperinflation occurs when prices rise

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at any moment and there is no level to which the prices might rise. During World War II certain countries experienced a hyperinflation, where the price index rose from 1 to over 1,000,000,000 in Germany during January 1922 to November 1923. How to reduce the level of inflation in an economy 1. REDUCE DEMAND PRESSURES If inflation is caused by high demand then * Raise interest rates to reduce consumers disposable incomes * Raise interest rates to discourage borrowing and demand * Raise taxes to reduce disposable income and spending

2 REDUCE COST PUSH PRESSURES Limit wage increases if possible e.g. public sector workers Force electricity and gas companies to hold their prices Increase the value of in order to reduce the cost of importing 3. REDUCE MONEY SUPPLY PRESSURES If inflation is caused by too much money in the economy Print less money Withdraw some money from circulation.

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Zimbabwe Inflation 'to Hit 1.5m%' Zimbabwe's inflation will rocket to 1.5m% before the end of the year, the US ambassador to Harare predicted today, forecasting massive disruption and instability that will drive President Robert Mugabe from office. In a telephone interview with the Guardian, Christopher Dell said prices were going up twice a day, sapping popular confidence in a government that is now "committing regime change on itself". "I believe inflation will hit 1.5m% by the end of 2007, if not before," Mr Dell said. "I know that sounds stratospheric but, looking at the way things are going, I believe it is a modest forecast." Zimbabwe's official inflation is 4,500% but independent economists and retailers say it is actually above 11,000% and picking up speed. The black market rate for the pound soared from Z$160,000 last week to Z$400,000 this week. The US dollar rate has topped Z$250,000, while the official rate is fixed at just Z$250. Mr Mugabe stubbornly insists that the Zimbabwe currency must not be devalued. "Prices are going up twice a day, in some cases doubling several times a week," said Mr Dell, who is approaching the end of his posting to Zimbabwe. "It destabilizes everything. People have completely lost faith in the currency and that means they have lost faith in the government that issues it. 38

"By carrying out disastrous economic policies, the Mugabe government is committing regime change upon itself," he said. "Things have reached a critical point. I believe the excitement will come in a matter of months, if not weeks. The Mugabe government is reaching end game, it is running out of options." For Zimbabweans living in the turmoil of economic meltdown, hyperinflation is spreading poverty, as even basic goods become unaffordable. Supermarkets' trollies lie idle as few can afford to buy more than a handful of goods. Government regulations will only permit withdrawals from banks of Z$1.5m per day, which is not enough to buy a Weeks worth of groceries. At golf courses, golfers pay for their drinks before they set off on their round, because the price will have gone up by the time they have finished the 18th hole. One individual was recently told by a pension company that it would no longer send him statements as his fund was worth less than the price of a stamp. "I can barely cope with inflation in the thousands, but millions? We will die," said Iddah Mandaza, a Harare factory worker. Mr. Mandaza said some workers are now saving on transport costs by "going to their jobs on Monday and sleeping at the workplace until Friday. They all share their meals. That's what they do to get by."

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Many Zimbabweans are resorting to barter. "I traded some soap for two buckets of maize meal [Zimbabwe's staple food]. It was far much better than trying to buy it in the shops," said worker Richard Mukondo. "People in the rural areas are even worse off. You can see they are hungry and their clothes are in tatters. They trade in whatever they can produce: tomatoes, onions, chickens and eggs." Tony Hawkins, professor of economics at the University of Zimbabwe, said that no one holds cash in the country any more. "People spend it as soon as they get it. Goods hold their value, not money. The government has run out of solutions. At this rate perhaps inflation could hit 1m%, but one gets a sense that things will crack before then." At the other end of the technological scale, enterprising Zimbabweans abroad have set up internet trading schemes, such as Mukuru.com, in which Zimbabweans overseas pay for goods with foreign currency and then vouchers for fuel, food and medicines are sent to recipients in Zimbabwe via email or on their cell phones. This business has thrived because more than three million Zimbabweans - a quarter of the country's 12 million people - now live abroad. Half of Zimbabwe's families depend on remittances from overseas to pay basic monthly bills, according to a recent survey by the University of Zimbabwe.

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Mr Dell, 51, who has had a tumultuous three years as ambassador to Zimbabwe, said that Mr Mugabe faces further trouble from his army, which used to be considered solidly loyal to the president. Last week six men, including an army private and a retired senior officer, were charged in court for plotting against the president. He said the allegations of the coup plot show divisions within Mr Mugabe's ruling party, the Zimbabwe African National Union-Patriotic Front (Zanu-PF). "I don't believe it was a real coup plot. I think it shows one side of Zanu-PF plotting against the other. The bitter factional infighting is now dragging in the military. That cannot be good news for Mugabe," said Mr Dell. South African president Thabo Mbeki's efforts to mediate between Zanu-PF and the opposition Movement for Democratic. Inflation and its impact on the Pakistan economy Inflation is the rise in the prices of goods and services in an economy over a period of time. When the general price level rises, each unit of the functional currency buys fewer goods and services; consequently, inflation is a decline in the real value of money a loss of purchasing power in the internal medium of exchange, which is also the monetary unit of account in an economy. Inflation is a key indicator of a country and provides important insight on the state of the economy and the sound macroeconomic policies that govern it. A stable inflation not only gives a nurturing environment for economic growth, but also uplifts the poor and fixed income citizens who are the most vulnerable in society. 41

ALL THREE INDICES CPI, SPI AND WPI AT A GLANCE Average JulyApril over same period of previous year (Change of indices in %) Index 2006-07 CPI SPI WPI 7.89 11.13 6.92 2007-08 10.27 14.09 13.70 2008-09 22.35 26.33 21.44

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INFLATION IN INDIA
The 1990s is widely described in general as a price stability era all over the globe. During the early part of the decade developed and developing countries alike experienced "a distinct ebbing of inflation", so observes India's central banking authorities, Reserve Bank of India (RBI). Inflation in India, barring some external factors like bouts of increase in international oil price and natural disasters like drought or flood, is showing an ebbing trend. The first half of India's fiscal 2002-03 (beginning April 1, 2002) witnessed uptrend in inflation largely due to increase in oil prices twice during the period and adverse impact of drought on agri- products leading to increase in prices particularly of oilseeds and edible oils. The efficient handling of supply management helped inflation eased in the second half of the fiscal. As a whole at the end of the fiscal 2002-03 inflation was up 3.3 percentage points. In the light of overall variation in wholesale price inflation, the inflation in fiscal 2002-03 was dominated by non-food items unlike preceding years, according to a RBI report. One of the major import contents of India's inflation in fiscal 2002-03 were edible oils and oil cakes that recorded highest price increase. Acute shortfall in production of the commodity led to about half the domestic demand met by imports. The RBI report also states that the underlying inflation (measured by average WPI) during this fiscal was dominated by manufactured product groups.

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Within manufactures again, edible oils, oil cakes and manmade fibres were largely responsible uppish trend in inflation. Inflation measured by average consumer price index for industrial workers (CPI-IW) however eased in fiscal 2002-03. Monthly Inflation Rate Table Monthly Month Inflation Rate January 2008 0.50% February 2008 0.29% March 2008 0.87% April 2008 0.61% 0.84% Red indicates May 2008 1.01% Deflation June 2008 (falling prices) -1.92% monthly = 23.04% Annual Deflation -0.50% monthly = 6% Annual Deflation .10% monthly= 1.2% annual inflation .20% monthly= 2.4% annual inflation .25% monthly= 3% annual inflation .50% monthly= 6% annual inflation .85% monthly= 10.2% annual July 2008 August 2008 September 2008 October 2008 November 2008 December 2008 January 2009 February 2009 March 2009 April 2009 May 2009 June 2009 July 2009 August 2009 September 2009 October 2009 November 2009 December 2009 January 2010 February 2010 March 2010 April 2010 0.53% -0.40% -0.14% -1.01% -1.92% -1.03% 0.44% 0.50% 0.24% 0.25% 0.29% 0.86% -0.16% 0.22% 0.06% 0.10% 0.07% -0.18% 0.34% 0.025% 0.41% 0.17%

inflation 1.00% monthly= 12% annual inflation The long term average inflation rate from 1913 through 2009 is 3.41% Current Inflation Rate May Jun Jul Aug Sep NA NA NA NA

Year Jan

Feb

Mar -

Apr -

Oct NA

Nov NA

Dec NA

Ave NA

2009 0.03% 0.24%

0.38% 0.74% 1.28%

2008 4.28% 4.03% 3.98% 3.94% 4.18% 5.02% 5.60% 5.37% 4.94% 3.66% 1.07% 0.09% 3.85% 2007 2.08% 2.42% 2.78% 2.57% 2.69% 2.69% 2.36% 1.97% 2.76% 3.54% 4.31% 4.08% 2.85% 2006 3.99% 3.60% 3.36% 3.55% 4.17% 4.32% 4.15% 3.82% 2.06% 1.31% 1.97% 2.54% 3.24% 2005 2.97% 3.01% 3.15% 3.51% 2.80% 2.53% 3.17% 3.64% 4.69% 4.35% 3.46% 3.42% 3.39% 2004 1.93% 1.69% 1.74% 2.29% 3.05% 3.27% 2.99% 2.65% 2.54% 3.19% 3.52% 3.26% 2.68% 2003 2.60% 2.98% 3.02% 2.22% 2.06% 2.11% 2.11% 2.16% 2.32% 2.04% 1.77% 1.88% 2.27% 2002 1.14% 1.14% 1.48% 1.64% 1.18% 1.07% 1.46% 1.80% 1.51% 2.03% 2.20% 2.38% 1.59% 2001 3.73% 3.53% 2.92% 3.27% 3.62% 3.25% 2.72% 2.72% 2.65% 2.13% 1.90% 1.55% 2.83% 2000 2.74% 3.22% 3.76% 3.07% 3.19% 3.73% 3.66% 3.41% 3.45% 3.45% 3.45% 3.39% 3.38%

Indias 2008 Economic Survey Report targeted a drop in Indias Inflation Rate but with food, oil and commodity price rises worldwide, the opposite is happening. According to the 2008 Economic Survey Report, Indias inflation rate was targeted by the Reserve Bank of India (RBI) to be 4.1%, down from a rate of 5.77% in 2007. Inflation rates for many investment goods have decreased dramatically in recent years. The price of basic goods such as lentils, vegetables, fruits and poultry were expected to slow their rise. The price of various manufactured goods also fell in 2007, and this contributed to a reduced inflation rate

However, the beginning of 2008 has seen a dramatic rise in the price of rice and other basic food stuffs. There has also been a no-less alarming rise in the price of oil and gas. When coupled with rises in the price of the majority of commodities, higher inflation was the only likely outcome.

Indeed, by July 2008, the key Indian Inflation Rate, the Wholesale Price Index, has risen above 11%, its highest rate in 13 years. This is more than 6% higher than a year earlier and almost three times the RBIs target of 4.1%. Inflation has climbed steadily during the year, reaching 8.75% at the end of May. There was an alarming increase in June, when the figure jumped to 11%. This was driven in part by a reduction in government fuel subsidies, which have lifted gasoline prices by an average 10%. 46

The Indian method for calculating inflation, the Wholesale Price Index, is different to the rest of world. Each week, the wholesale price of a set of 435 goods is calculated by the Indian Government. Since these are wholesale prices, the actual prices paid by consumers are far higher. How India calculates inflation

India uses the Wholesale Price Index (WPI) to calculate and then decide the rate of inflation in the economy. Most developed countries use the Consumer Price Index (CPI) to calculate inflation.

WPI was first published in 1902, and was one of the major economic indicators available to policy makers until it was replaced by the Consumer Price Index in most developed countries by in the 1970s. WPI is the index that is used to measure the change in the average price level of goods traded in wholesale market. In India, price data for 435 commodities is tracked through WPI which is an indicator of movement in prices of commodities in all trades and transactions. It is also the price index which is available on a weekly basis with the shortest possible time lag -- two weeks. The Indian government has taken WPI as an indicator of the rate of inflation in the economy. CPI is a statistical time-series measure of a weighted average of prices of a specified set of goods and services purchased by consumers. It is a price index that tracks the prices of a specified basket of consumer goods and services, providing a measure of inflation. CPI is a fixed quantity price index and considered by some a cost of living index. Under CPI, an index is scaled so that it is equal to 100 at 47

a chosen point in time, so that all other values of the index are a percentage relative to this one.

Some economists argue that it is high time that India abandoned WPI and adopted CPI to calculate inflation. India is the only major country that uses a wholesale index to measure inflation. Most countries use the CPI as a measure of inflation, as this actually measures the increase in price that a consumer will ultimately have to pay for.

CPI is the official barometer of inflation in many countries such as the United States, the United Kingdom, Japan, France, Canada, Singapore and China. The governments there review the commodity basket of CPI every 4-5 years to factor in changes in consumption pattern. WPI does not properly measure the exact price rise an end-consumer will experience because, as the same suggests, it is at the wholesale level. The main problem with WPI calculation is that more than 100 out of the 435 commodities included in the Index have ceased to be important from the consumption point of view. Take, for example, a commodity like coarse grains that go into making of livestock feed. This commodity is insignificant, but continues to be considered while measuring inflation. India constituted the last WPI series of commodities in 1993-94; but has not updated it till now that economists argue the Index has lost relevance and can not be the barometer to calculate inflation. 48

The WPI is published on a weekly basis and the CPI, on a monthly basis. And in India, inflation is calculated on a weekly basis and announced on every Friday.

Inflation Rate, Rate of Inflation The inflation rate is the percentage by which prices of goods and services rise beyond their average levels. It is the rate by which the purchasing power of the people in a particular geography has declined in a specified period.

The rate of inflation may be calculated weekly, monthly or annually. However, it is always expressed as an annualized figure. Inflation Rate: Indices The inflation rate can be calculated for different price indices. For the national inflation rate, the consumer price index (CPI) is considered. This index measures the actual prices of goods and services needed by the common man. The inflation rate can also be measured by the following indices: Cost-of-living index (COLI): This is used to adjust income scales so that the real value of earnings remains the same. Producer price index (earlier Wholesale Price Index): This measures the average change in prices that domestic producers receive for their products. This index measures the growing pressure on producers due to changes in the costs of their raw materials. This pressure might get passed on to consumers, absorbed by profits or offset by a rise in productivity. 49 Commodity price index: This measures the prices of a selected group of commodities. Core price index: This removes the volatile components (primarily food and oil) from broader indices, like the CPI. Short term changes in demand and supply conditions do not significantly affect such indices. Central banks use it to assess the need for adjusting the monetary policy. Methods of Calculating the Inflation Rate The two main methods used to calculate the inflation rate are:

 Base period: This method is the more common of the two and assigns a relative weight to each element while making calculations. Chained measurements: In this method, the contents of the commodity bundle are adjusted, along with the prices. Besides, individual time periods in which the price levels fluctuate are also taken into account. Any undesired change in the rate of inflation can affect the economy and national development at large. The appropriate estimation of inflation rates is necessary to get an overview of the national economy. Inflation Rate: The Formula The equation to calculate the inflation rate is: Inflation Rate = (Po- P-1)* 100 / P-1, Where Po = the present average price P-1 = the price that existed last year. 50

The inflation rate is always stated as a percentage. Another way of calculating the inflation rate is to apply the log rule. The inflation rate is important, since it is subtracted from various economic rates in order to eliminate the impact of inflation. The real increase in wages is also counted by taking into account the prevailing inflation rate.

Current Inflation, Current Inflation Rate The current inflation rates across the world, as of April 2009, were low due to the global recession that peaked in September 2008. The recessionary pressures felt across the globe resulted in a massive decline in the supply of money. This, in turn, affected commodity prices, resulted in low inflation rates. Current inflation is measured by the International Monetary Fund. Current Inflation Trends in the World According to an IMF report, headline inflation in the developed nations is expected to decline from 3.5% in 2008 to a record low of 0.25% in 2009. It is expected to recover to 0.75% in 2010. In the emerging economies, inflation is expected to fall to 5.75% in 2009 and 5% in 2010, from 9.5% in 2008. For the quarter ended March 31, 2009, the current inflation rates of major nations are listed in the table given below:

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Countries New Zealand UK Australia EU Japan US

Current Inflation (%) 3 2.9 2.5 0.6 -0.3 -0.4

Calculation of Current Inflation Rates

Current inflation rates are calculated for different timeframes from as short a period as a week to as long as a year. Short-term inflation rates facilitate the analysis of the sudden effects of economic, political and social changes on current inflation. Long-term rates are a better measure, as they reflect the economic situation in a more comprehensive way by rounding off the effects of sudden price movements.

The current inflation rates released by the IMF and various national governmental bodies are calculated on an annual basis. The weekly and monthly figures announced by these organizations are annualized figures. 52

Current Inflation and Unemployment According to an ILO report, the world unemployment rate is projected to reach 7.1% in 2009 if the sluggish economic performance continues. This is estimated to increase worldwide unemployment by 50 million. According to the Bureau of Labor Statistics, 651,000 jobs were lost in February 2009 in the US alone. The IMF has projected world economic growth at 0.5% for 2009, a record low since World War II. However, given the constant efforts to ease credit

strains by implementing expansionary fiscal and monetary policies, the world economy is expected to recover by 2010. Core Inflation, Core Inflation Rate Core inflation is a measure of inflation that excludes items such as food products and energy, which are prone to volatile price movements. The concept of core inflation rate was introduced by Robert J. Gordon in 1975. Significance of Core Inflation Core inflation is an indicator of long-term inflation at a fundamental level. It is considered while framing monetary policies, as it supports the primary goal of central banks price stability along with sustainable economic output and employment. Core inflation does not consider products that are easily influenced by supply shocks. This is because such items can move away from the overall inflation trend and represent a false picture. 53

Measuring Core Inflation Core inflation is calculated in various ways: 1. Outliers method: This excludes products that have the largest price changes. 2. Statistical methods: These include trimmed mean and weighted mean. These methods are derived from a highest-to-lowest ranking of individual price changes for each given month.

3. Consumer Price Index (CPI): This measures inflation and excludes the prices of volatile products such as food and energy. Monitoring the Core Inflation Rate In an economy facing inflationary pressure, the central bank typically aims at controlling the core inflation rate, as this is easier to control.

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RBIS CREDIT POLICY REVIEW: GROWTH VS INFLATION

Inflation control at the cost of growth seems to be message being sent by the RBI in the first quarter review of Monetary Policy for 2008-09. Reserve Bank of India has hiked key rates in order to curb credit growth and has simultaneously lowered its expectation of GDP growth rate. Banks have been sounded off on the merits of good quality credit. The Reserve Bank of India announced its first quarter review of the Monetary Policy for 2008-09, and there is no good news. Inflation figures

are looking higher than ever and the central bank announced an extremely hawkish policy to control the spiraling prices, and ready to forsake growth in the process. Highlights: RBI hikes repo rate by 50 bps; CRR by 25 bps | Interest rates may rise as RBI tightens monetary policy | 'RBI measures to contain inflation' The central bank has kept the Bank Rate and reverse repo rate unchanged, but has hiked the repo rate by 50 basis points, from 8.5 per cent to 9 per cent. The Cash Reserve Ratio (CRR) has been increased by 25 basis points to 9 per cent with effect from August 30, 2008. CRR has touched 9 per cent for the first time since 2000.While expressing alarm at the double-digit inflation, RBI has given the impression that it will not come down anytime soon. 55

It has projected a realistic inflation rate of 7 per cent by March 2009. However, the GDP growth rate has been revised downwards as well. The expectation now stands at 8 per cent for FY09 as against 8-8.5 per cent as announced in the Annual Policy in April, earlier this year. Auto shares slump after RBI policy | RBI trims GDP growth rate to 8% | Housing, consumer loans to become costlier. Severe targets have been set for growth in money supply. While the target for M3 is 17 per cent, credit growth has been set a target of 20 per cent and deposit growth of 17.5 per cent.

Strictures for banks Simultaneously, commercial banks have been given strict instructions about the quality and quantity of credit. Banks have been asked to review their long-term business strategies, which should not only be viable, but focus on credit quality as well. RBI would like to review these strategies from time to time, it said. The central bank has given a word of caution, said T S Narayanasami, CMD, and Bank of India. It appears that banks have been sounded off on the perils of credit expansion. The central bank has kept in mind the worsening trade deficit and growing concerns over fiscal deficit, before setting these targets. With a more than expected slowdown in industrial and service sector growth, RBI wants to make demand control its goal, therefore credit growth must be moderate. This is evident from the first quarter policy review There is pressure on banks to increase lending rates, according to M D Mallya, Chairman and Managing Director, Bank of Baroda. 56

How does all this impact the growth story? The hike in repo rate and CRR seems to be an ongoing process. HDFC has predicted another 50-70 basis points hike in the repo rate during the coming months. A curb on credit expansion, could impact the investment demand of the corporate sector. Even though banking is a small part of the growth story, a 100-125 basis points increase in the lending rates could raise the cost of funds in the system considerably.

So far, the consistent but moderate increases in lending rates have applied to the retail side of banking. Now they could affect the investment side. Once access to capital is restricted and recourse to external finance is limited, the expansion programme of several corporates could be put on hold or curtailed. Could this sluggishness in growth persist? If investment becomes moderate, we may find the average rate of growth of GDP to be in the range of 7-8 per cent over the next 2-3 years, according to economists. While FY08 promises to be a difficult years, the impact of curtailed demand and sluggish investment will be felt with a lag in FY10. Heres what a few banks have to say. While Deutsche Bank has predicted a GDP growth rate of 7.3-7.8 per cent, HSBC is expecting the GDP to grow at 7.5-7.8 per cent during FY09. 57

India was looking at catching up with China in the growth story. However, stumbling blocks like inflationary pressures, caused by external and internal shocks, has postponed its plans for now. Inflation control at the cost of growth has become a reality.

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CONCLUSION:After reading this tutorial, you should have some insight into inflation and its effects. For starters, you now know that inflation isn't intrinsically good or bad. Like so many things in life, the impact of inflation depends on your personal situation. Some points to remember:

Inflation is a sustained increase in the general level of prices for goods and services.

When inflation goes up, there is a decline in the purchasing power of money. Variations stagflation. on inflation include deflation, hyperinflation and

Two theories as to the cause of inflation are demand-pull inflation and cost-push inflation. When there is unanticipated inflation, creditors lose, people on a fixed-income lose, "menu costs" go up, uncertainty reduces spending and exporters aren't as competitive. Lack of inflation (or deflation) is not necessarily a good thing. Inflation is measured with a price index. The two main groups of price indexes that measure inflation are the Consumer Price Index and the Producer Price Indexes. Interest rates are decided in the U.S. by the Federal Reserve. Inflation plays a large role in the Fed's decisions regarding interest rates. 59

In the long term, stocks are good protection against inflation. Inflation is a serious problem for fixed income investors. It's important to understand the difference between nominal interest rates and real interest rates. Inflation-indexed securities offer protection against inflation but offer low returns.

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Bibliography

www.inflation.Com www.indiabudget.com www.google.com www.yahoo.com www.businessballs.com Magazine & Newspapers

Outlook Express Economics times Financial times DNA

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