inflation a strategy to check it

8/6/2019 Inflation a Strategy to Check It

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Inflation a strategy to check it


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Content

Introduction Important characteristics

Features of Aggregate Demand Vs Aggregate Supply

Factors causing demand pull / cost push

Types of Inflation

Measurement of InflationWPI & CPI

Inflation levels across developed & developing economy

Phillips curve

Effect & Impact on Economy

Strategic control mechanism Life cycle of inflation

Summary

References


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Introduction

Inflation refers to a rise in price level afterfull employment level has been achieved

John Maynard Keynes

It is a phenomenon of continuous increasein general price levels in a given period.

It is measured by taking the percentagechange in the price index.


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Important characteristics

Continuous: rather than one off process

Increases in general price levels: rather than prices of specific

goods

Demand pull Cost push

Aggregate demand higher than

aggregate supply

Major factors

Increase in money supply,

Government budget deficit,

Increase in export earnings,

Unemployment level remains

minimum

Cost of factors of production

increases supply reduces

aggregate demand remains same

Major impact

Unemployment level increases to

maximum


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Features of Aggregate demand & supply

Aggregate Demand refers tothe collective behavior of all

buyers in marketplace.

Aggregate Demand

0

20

40

60

80

100

1st Qtr 2nd Qtr 3rd Qtr 4th Qtr

Real Output (Qty peryear)

Pricel

evel(Average

price)

Aggregate Supply is the realvalue of output producers are

willing & able to bring to

market at alternative price

levels.

Aggregate Supply

0

20

40

60

80

100

1st Qtr 2nd Qtr 3rd Qtr 4th Qtr Real Output (Qty per year)

Pricelevel(Average

price)

Effects

Real Balance Effect

Foreign trade

Interest rate effect

Effects

Profit Effect

Cost effect


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Factors causing demand / cost push

Inflation Factors Impact Explained

Demand

Pull

Real: Increase in Government

expenditure with no change in

tax receipts or vice a versa

Monetary: Decrease in

demand for money or Increasein supply

Increase in

consumption,

export, investment

Cost

Push

Originating from supply side,

increase in wage levels not

matched by productivity

increase in profit margins whoexercise market power

Monopolists / oligopolists

Supply shock inflation

increase in cost of raw material

or shortage due to natural

calamities

Increase in labor

cost per unit

higher cost of

living fall in realwages

0

20

40

60

80

100


Real Output ( Qty per year)

0

10

20

30

40

50

60

70

80

90

100


Real Output (Qty per year)

Pricelevel(Averageprice)

X

A

B

P

Y

Q


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Types of inflation

Types Defined Impact

Modest Very low level of inflation (2% - 3%) Slow but steady growth

Creeping Increase in price levels are small & gradual

(5% - 10%)

Induces investments in

economy

Running Continuous creeping inflation withoutadequate monetary or fiscal control will lead

to running inflation (8% to 10%)

Reduce savings,

Hindrance to future

economic growth

Hyper of

galloping

When monetary authorities completely lose

control on running inflation it will lead to

galloping inflation

Increase in velocity of

circulation of money

Deflation Price decrease in some goods / servicesoverweigh increase in price of other goods /

services

Inflation becomes negative &

asset price tumbled (Eg

Japan in 1995)


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Inflation how measured

Wholesale PriceIndex WPI indicator designed to measure changesin price level of commodities in wholesale trade intermediaries

Consumer PriceIndex CPI is measured on the basis of changes inretail prices of selected goods & services (essential goods)

Producers PriceIndex PPI is a family of indexes that measures theaverage change over time in the selling prices received by domesticproducers of goods and services

As of now inflation is measured through WPI, The consumer price

index is the most commonly cited measurement of inflation. Withundue changes in inflation rate, the Indian Government is giving athought to switch over to a more realistic way of measuring inflationthrough PPI that would replace WPI


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Measurement of Inflation

Wholesale Price Index

(WPI)

Consumer Price Index

(CPI)

Producers Price

Index (PPI)Measures the different prices

of a basket ofcommodities

in the wholesale markets.

Made up of 98 - Primary

products; 19 - Fuel, Power,Lubricant products;318 -

manufactured products.

The office of economic

adviser (OEA) in the Ministry

of Industry compiles the WPI.

Started in 1942 with baseyear as 1939.

Frequent revision in the base,Present base year 1993-94.

As ofnow the inflation is

measured through

wholesale price index

The CPI reflects the cost ofliving of

a particular group in the population

Based on changes in retail prices

of selected goods and services

(essential goods) on which a

particular group of consumers spend

their moneySeveral consumer price indices

ForIndustrialWorkers : CPI-IW

(Basket of 260 products)

ForUrbannon-manualemployees

: CPI-UNME (Basket of 180

commodities)

ForAgricultural Labours : CPI-AL(Basket of 60 commodities)

Data is collected through family

budget surveys

Base year is changed every few

years to take care of tastes /

appearance of consumption basket.

PPI is a family of

indexes that measures

theaveragechange over

time in the selling prices

receivedbydomestic

producers ofgoods andservices

The target set of goods

and services included in

the PPIs is the entire

marketed output of

producers. The set

includes both goods andservices (imports

excluded)

The price collected for an

item included in the PPIs

is the revenue received by

its producer


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WPI/CPI/PPI critical analysis

Wholesale Price Index(WPI)

Consumer Price Index(CPI)

Producers Price Index(PPI)

WPImeasures the prices

ofboth inputs and outputs

with the inclusion of taxes

paidby producers

Available at frequent levels

continuous monitoring of

price levels are possible

Duration is usually 1 or 2

weeks

Services & non-tradable

commodities excluded

The price collected for an item

included in the CPI is the out-of-

pocket expenditure by a

consumer for the item. Sales andexcise taxes are included in the

price

The target set of items included

in the CPI is the set of goods and

services purchased for

consumption purposes by urban

households (including imports).

PPI requires only prices of

outputs excluding

intermediatecosts and

taxes

The PPI methodology

provides easily understood

data & transparent

methodology as a whole

process.

The PPI methodology

automatically factors in theeffects of inflation as well as

the effects of changes in

wages and/or prices.

drawback in PPI is its hugedependence on the quality of

data voluntarily provided by

the respondents


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Weighting diagram of WPI & CPI

WPI Weight

All commodities 100.00

Primary Products 22.02

Food Articles 15.04

Paan, Supari, Tobacco 3.15

Fuel Group 14.23

Coal Mining 1.75

Housing 8.67

Manufactured products 63.75Food Products 11.54

Miscellaneous 16.36

Basic Metals 8.34

CPI Weight

All commodities 100.00

Food 57.00

Non-Food articles 6.14

Minerals 0.48

Fuel & Light 6.28

Mineral oils 6.99

Electricity 5.48

Clothing, Bedding 8.54Textiles 9.80

Chemicals 11.93

Others 21.62


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CPI status of India


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Consumer Price Index across Globe


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Inflation Level across developing countries


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Phillips curve

British Economist A W Philips pioneered the relationship between therate of employment and rate of wage increases

Important findings:

Inverse relationship : when wage rate rises low unemployment& vice a versa

Wages increase not matched by increase in labour productivityconverted into increase in price level

Organized labor can cause autonomous increase in wage rates inexcess of increase in productivity

The link between price changes and employment goes beyond the

dynamics of the labour markets.


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Economic Impact of Inflation

Effect of Inflation on the distribution of Income &

Wealth Different income groups of society negative effect more on

fixed income groups

Debtors & creditors debtors gain / creditors loose

Producers - gain

Investors equity investors gain / fixed income security investors

loose, Reduction in the real value of investment

Erosion of purchasing power


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Effect of inflation -------- contd..

Positive effects Adverse effects

Mild inflation

stimulates production &

lead to near full employment

encourages capital

investments

Hyperinflation Adversely affect

production

Decreasing purchasing

power

Discourages people from

saving

Hoarding of stock reducing supply & lead to

black marketing

Production shifts from

consumer to luxury goods.


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How can we control Inflation

Dontworry. I

think I canfix it

This graphis terrible!


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Strategies by Government / RBI /FM to

control inflation

Monetary Measures

Monetary Policy (money supply, credit control and bank rate)

Fiscal Measures

Public expenditure (increase / reduction)Taxation (higher taxes & duties on luxurious goods)

Public borrowing and debt (introduce special savings program

to divert consumption into savings)

Other Measures

Price control and rationing

Wage policy


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The Life cycle of Inflation

Overheating inflation growth

Output Inflation

Recession-Stagflation

Output Inflation Recession-Deflation

Output Inflation

Recovery-Non inflationary growth

Output Inflation


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Summary

Inflation is one important economic variable which is playing anever-expanding role in the decision making process of business,industry and government

Inflation affects real income tax liabilities in two ways.

It erodes the real values of fixed deductions.

It moves a tax payer in a high tax bracket. Low income groups

suffers more than high income groups during inflation "Containing inflationary expectations would continue to pose a

challenge to monetary management," RBI annual report 2005-06.

Is there a trade-off between inflation and employment?

Can policy-makers generate more employment through adeliberate policy of inflation

CPI or PPI Does it have any effect in controlling the current trend in

inflation??

Inflation measured in terms of variation in wholesale prices was 4.92percent, as compared with 3.7 per cent a year ago


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References

Web sitesReserve Bank of India

Government of India : Labour Bureau

IMF working paper Sources of Inflation in

Developing countriesIIMA

India Policy Forum Meeting paper How applicableis Inflation Targeting Framework (ITF) for India

IC

IC

I Bank e-business sitehttp://ebusiness.icicibank.com/research/

Managerial Economics - Trivedi

Economics for Managers ICFAI

Economics Subject Notes


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inflation a strategy to check it

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