1. Inflation
Inflation is a general rise in prices of goods and services. Inflation results in loss of value of money. If
some commodity demands a price of 10 rupees 10 years ago, it now demands Rs. 50. This means there
is loss in value of rupee by about five times w.r.t. to that commodity. So in general all commodities
appreciate over time. This is inflation. Inflation can be compared to nature. One talks about it but does
nothing about it.
As in the case of nature, which is thus far beyond our control, one can take certain defensive measures
to offset the impacts of inflation. Hence most economies have not had much success in dealing with
inflation. Two U.S. presidents (Ford and Car­ter) have referred to it as “public enemy number one”.
Indian Prime Minister Dr. Manmohan Singh calls it the first priority of his government to suppress
inflation below acceptable levels. Inflation remains a matter of concern because it is inevitable,
per-sistent, and apparently immune to numerous remedies. Experts in the economics and numerous
politicians have tried to give various solutions, none of which have gained absolute acceptance. The
nature is tolerated because one cannot control it; inflation is not, because it is thought to be
controllable–at least within limits.
Inflation has been defined as too much money chasing too few goods. This attributes the cause of
inflation to monetary growth relative to the output of goods and services. Inflation is a persistent rise in
the general level of prices of all good and services taken together. A specific price in one commodity
may rise dramatically as in the case of oil or gas. But if this specific price is nullified by declines in prices
of other commodities, the general price level may not rise at all i.e. there is no inflation. The general
level of prices depends on a series of individual price changes and their relative importance some
measure of these factors, namely, a price index is required.
But rise in some individual price index will not result into what is generally meant by inflation, its
consequences won’t be particularly serious if the change in the price index quickly reversed itself and
price stability is maintained. To become and remain a problem demanding concern, it should involve a
long suc-cession of increases in a price index.
A price index’s acceleration must take a fairly sharp increase over some previous norm or accustomed
level–a rise that either continues to accelerate or that stays at the new higher level. From 1967 on, the

2. CPI (a form of index for measuring inflation) increased at rates well above 4% and the rate of increase
has risen steadily from 6% per annum in 1976 to about 13% in 1979-1980.
Thus inflation can be defined as a sharp increase in the rate of change of a price index above an
acceptable level that lasts over a time period long enough to create expectations of its future
persistence.
Inflation and economy
The rate of inflation and the economy are closely related to each other. The growth of the economy of
the nation is judged by the growth in the Gross domestic product or the GDP but that is not enough to
be able to understand as to how many people are actually doing well because of the rise in the Gross
domestic product. The Gross domestic product is a gauge often used by the Government to show that
India is indeed doing well. But often these ratings are not a mirror image of what seems to be happening
in the country because the inflation rate is also a tool which helps us to witness what the common man
is going through because the inflation rate carries with itself the prices of fruits, vegetables, cereals and
other essential commodities which are required for daily usage.
The Inflation rate in India often crosses six or seven percent. Out side of India in the developed countries
the rates of seven percent and beyond are unheard of. But in India the inflation goes high at several
times. It has also led to the downfall of various governments who have been ineffective in controlling
the rate of inflation and hence have invoked the anger of the people. The economic condition of the
country and the rate of inflation go hand in hand and they should not always be talked about as alien to
each other or not connected.
And hence countries should be looking at a high GSP growth and also on the other hand, low rates of
inflation which will all be beneficial to the country and its people.
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Inflation Rate

3. Since the economic reforms in 1991, the Indian economy has been growing year after year. The past
decade and a half has seen the Gross Domestic product that is the GDP rise to scorching height. But
the downside is that in the past few years, the inflation rate has also been going up which a cause of
concern for the economists as well as the members of the Government. Thus this high growth of
economy has also been a reason for the rise in the Inflation rates.
The inflation rates are closely monitored by the Government for it is the inflation rate that has a direct
impact on the common man. The Gross domestic product or the GDP may be extremely high but it
may not have a direct impact on the common man where as the inflation rate surely does. Thus a high
inflation rate is detrimental to the overall growth of the country and hence should be avoided. The
Reserve bank of India or the RBI takes effective steps in order to reduce the rate of inflation whenever
it reaches alarming heights. Inflation has a direct impact on the prices of fruits, vegetables and other
basic necessities. The Reserve bank if India some times increases the cash reserve ratio or the CRR in
order to arrest the rampaging rate of inflation.
The rate of Inflation if within the range of two o four percent is said to be moderate but once it starts
to grow beyond the five percent it raises the alarm bells. India has at times witnessed an inflation rate
of greater than seven percent as well and touching eight or nine percent. In such circumstances, the
Government gets under tremendous pressure to start trying to reduce the rate of inflation.
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Inflation In World
To be able to understand the rate of inflation in the World, we would have to be looking individually at
the inflation rates of the countries. Almost all around the World the inflation seems to be going high as
compared to what the inflation rates were perhaps about a decade or two back. The central banks of
respective countries have been trying hard to be able to reduce the inflation rate in their respective
countries and hence curb the effects of inflation. As per the data of the year 2007, such was the
scenario of the inflation rates around the World.
In entire North America, that is the parts of the United States of America, Canada in the north and
Mexico, the inflation rates were managed at a healthy two to five percent. But in South America it was
a different story altogether with most of the countries displaying a very high rate of inflation as
compared to parts of North America with the inflation rates going above the mark of fifteen percent in
many countries. In parts of India and the nearby countries of Pakistan, Nepal and Bhutan all belonging
to the Indian subcontinent, the inflation rates at an average were found out to be between five to ten
percent. In parts of china the inflation rates were a bit lower than that.
In all the parts of Europe, the inflation rate was manageable not going beyond the mark of five
percent. But in parts of Africa, many countries had inflation rates above ten percent. Zimbabwe has
seen the inflation rate going upward every year for the past few years. In Australia and New Zealand,
the rate of inflation was again below five percent whereas in parts of Russia, it was more than ten
percent.

4. How inflation is measured
To measure inflation, a number of goods that are representative of the economy are put together into
market basket. It is then compared over time. This results in a price index. Price index shows the
changes in the cost of the present market basket as a percentage of the cost of that identical basket
in the previous year.
There are two main price indexes that measure inflation:
Consumer Price Index (CPI) – A measure of price changes in the retail market of consumer goods
and services such as petrol, food, clothing and automobiles. The CPI measures price change from the
perspective of the retail buyer. It is the real index for the common people. It reflects the actual
inflation that is borne by the individual. This is not taken into consideration in India.
Wholesale Price Index (WPI): It is used in India. It takes into account the rise in prices of goods
and services in a select range of goods and services at the wholesale level. Since the general public
does not buy at the wholesale level, it does not give the actual feeling of the amount of pressure
borne by the general buyer. But the increase in wholesale prices does affect the retail prices and as
such give a feeling of the consumer prices.
Producer Price Indexes (PPI) – A group of indices that measure the average change over time in
selling prices by producers of goods and services. They measure price change from the point of view
of the seller.
Cost-of-living indices (COLI): These show the fixed incomes and contractual incomes based on
measures of goods and services price changes.
In the long run, the various PPIs, WPIs and the CPI show a similar rate of inflation. In the short run
PPIs often increase before the WPI and CPI. Investors generally follow the CPI more than the PPIs. In
India WPI is used instead of CPI.
Inflation control
Controlling inflation is one of the most important objectives of government economic policy in many
countries. Effective policies to control inflation focus on the causes of inflation in the economy.
Monetary policy controls the growth of demand by creating an increase in interest rates and a
reduction in the real money supply.
Higher interest rates reduce aggregate demand in three main ways:
• Discouraging borrowing by both households and organizations.
• Increasing the rate of saving. Thus people will save more and spend less. Thus money in the market
will be less

5. • The rise in mortgage interest payments will reduce homeowners‘ real ‗effective‘ disposable income
and their ability to spend. Increased mortgage costs will also reduce market demand in the housing
market
• As the cost of borrowing will increase business investment may also decrease.
The government generally alters the fiscal policy to fight inflation:
• It increases the direct taxes thus causing a fall in disposable income
It lowers spending which decreases demand
Exchange rate appreciation:
An appreciation in the currency makes exports more expensive and reduces the volume of exports and
boosts supply thereby reducing aggregate demand. It also demands firms to keep costs down to
remain competitive in the world market. A stronger currencies reduces import prices. This makes raw
materials and components cheaper.
Labour market reforms:
The weakening of trade union strength, the growth of part-time and temporary workforce along with
the concept of flexible working hours have increased flexibility in the job market. This helps get
maximum productivity out of individuals and companies.
Supply-side reforms:
Supply side reforms seek to increase the productivity of the economy in the long run and raise the
rate of growth of capital productivity. Productivity helps to control unit costs and eases pressure on
producers to raise their prices.
Food inflation
The rise in prices of edible commodities is called food inflation. Today, we are going through the worse
level of inflation in the last 17 years. The overall rise in food prices in 2007 in the U.S., according to
federal statistics, seems to be bearable — 4 percent. But it is the highest rate since the early 1990s,
and it is more than the pay raises most people are receiving and it definitely seems to be getting
worse.
The most significant part is that prices for many staples are rising much faster than the overall
consumer price index for food. Eggs are 25 percent milk is up 13 percent, cheese nearly 15 percent
costlier than a year ago. In Pakistan and Thailand, paramilitary troops have been deployed to prevent
food theft from farms and storehouses.
World Bank president Robert Zoellick warned that 33 countries are at risk of social agitation because
of rising food prices. Much of this rise is being attributed to the diversion of food-crops into energy
generation .For example; maize is extensively used to make bio-diesel. This causes a lot of pressure
on maize prices which then cause all the commodities to go up. Also, a lot of farms in Brazil are now
cultivating plants like jathropa which is used to make bio diesel, instead of food grains.
This is creating scarcity of food grains in the world market shooting up prices. Countries like India
have placed severe restrictions on export of food grains from their country causing a speculative
interest in commodities all over the world. Thailand, which is largest exporter of rice in the world, is
not able to export enough of it. This has led to two fold increase in the price of rice.

6. Effects of Inflation
A small amount of inflation is viewed as having a beneficial effect on the economy. One reason for this
is that it is generally difficult to renegotiate prices and wages once they are fixed to a level. With
increasing prices it is easier for relative prices to adjust automatically.
Because of inflation, the price of any given good is likely to rise over time, hence consumers and
businesses may choose to make purchases sooner than later before the worth of their money has
eroded. This effect will keep an economy active in the short term by encouraging spending and
borrowing. But inflation also reduces incentives to save, so the effect on savings and investments is
negative. High or unpredictable inflation rates are regarded as bad.
Following are effects of inflation on individual, organizations and government:
Redistribution of wealth:
Inflation redistributes wealth from those on fixed incomes, such as pensioners, and shifts it to those
who do not have a fixed income (income which takes into account cost of living), for example from
wages and profits which may keep pace with inflation.
Individuals who are indebted in any way may be helped by inflation because of decrease in the real
value of debt. As such, inflation siphons off wealth from those who lend to those who borrow.
Income tax brackets tend to become distorted. Governments that allow inflation to rise sharply are, in
effect, allowing a tax increase because the same real purchasing power is being taxed at a higher rate.
Distorted Economic Decisions: If there is higher inflation, manufacturers that do not adjust their
prices will have much lower prices relative to firms that adjust them. This will distort economic
decisions. For eg: suppose iron ore prices rise while steel prices do not then steel manufacturers might
want to buy steel available through other sellers rather than manufacturing themselves.
Rising inflation prompts workers to demand higher wages, to keep up with prices. Rising wages cause
more money supply in the market which helps inflation rise. This can cause a spiral in wage and
inflation.
Cause of Inflation
Inflation is a monetary phenomenon .It is also affected by the fluctuations of wages, prices and
interest rates. There are two schools of thought which define the causes of inflation. In monetarist
school of thought, the availability of money in the market causes rise in prices of goods and services
and prices and wages adjust quickly to make other factors merely marginal. In the Keynesian view,
prices of goods and wages adjust at their own rates, which fluctuate real output.
There are three major types of inflation:
Demand-pull inflation: Here inflation is supposed to be caused by increases in aggregate demand
due to availability of excess money which can be because of increased private and government
spending, etc.
Cost-push inflation: It is caused by drops in aggregate supply due to increased prices of inputs. For
eg: a sudden decrease in the supply of oil, which would increase oil prices. Manufacturers for whom oil
is a part of their costs will then pass this on to consumers in the form of increased prices.

7. Built-in inflation: It is induced by expectations, inked to the ―price/wage spiral‖ because it consists
of workers trying to keep their wages up with prices and then employers passing higher costs on to
consumers as higher prices .This forms a ―vicious cycle.‖
According to Monetarists inflation is caused by an increase in the amount of money in market relative
to the capability of the economy to supply. This happens when governments finance spending in a
crisis, such as a civil war, by printing money excessively, often leading to hyperinflation, a condition
where prices can double in a month or less. The current rise in inflation all over the world is said to be
because of this theory. To subvert the possibility of a sub prime crisis the Federal Reserve (Central
Bank Of the U.S.) is printing excessive money and introducing large supply of cash in the market. This
excessive supply is being used by people to buy more goods. This results in rise in demand of the
goods thereby increasing their prices.