Inflation means rise in the price of goods or services in an economy. It is also called erosion of purchasing power of money because due to inflation, one can be able to purchase less quantity of goods for each of the currency he spends. In context of India, the supply of goods and services has been rising but the rise in supply has not been proportionate and does not match the rise in demand; this is due to monsoon agriculture, use of backward technology, bottlenecks in transport and power, and shortages of various inputs. At any given time, there is a demand-supply imbalance; which results in the increase in price of the goods.
FACTORS RESPONSIBLE FOR INFLATION IN INDIA:
1) MOUNTING GOVT EXPENDITURE:
Government expenditure has been steadily and continuously increasing over the years. The total expenditure of both central and state governments rose from nearly Rs 740 crore in 1950-51 to Rs 37000 crore in 1980-81, and Rs 6, 55,855 crore in 2000-01. Mounting government expenditure implies a growing public demand for goods and services and, thus, is an important factor for the rise in prices.
2) DEFICIT FINANCING AND INCREASE IN MONEY SUPPLY:
While revenue deficit has been rising in recent years, fiscal deficit has been rising at a much faster rate. The disturbing fact is the method of financing the fiscal deficit -through borrowing from the market at high rates of interest.
3) ROLE OF BLACK MONEY:
It is well known that there is a large accumulation of unaccounted money in the hands of income -tax invaders, smugglers, builders, corrupt politicians and govt. servants. It was estimated around Rs 600000 crore in 1997-98.
4) UNCONTROLLED GROWTH OF POPULATION:
It is the continually rising population which is responsible for the persistent gap between demand and supply in almost all consumer goods and services, thus exerting continuous pressure on prices.
COST- PUSH FACTORS:
1) FLUCTUATIONS IN OUTPUT AND SUPPLY:
In this connection, we may refer to violent fluctuations in food grains output. The production of food grains was 89 million tonnes in 1964-65. The following year it declined to 72 million tonnes, a 20% fall in a year. Again in 1970-71, the production was 108 million tonnes. But it falls to 97 million tonnes in the next two years. Same thing repeated this year too. Such kind of fluctuations in output of food grains in certain years are a major factor in the rise of food grains as well as general prices.
2) TAXATION AS A FACTOR IN RISING COSTS:
Cost-push factors consist mainly of rise in wages, profit margins, and other costs. With every budget, the govt. imposed fresh commodity taxes and gave an opportunity to the trading classes to raise the prices, often more than the levy of taxes.
3) HIKE IN OIL PRICES AND GLOBAL INFLATION:
Serious inflationary pressures were also created due to sharp hike in the price of crude oil. The gulf surcharge which raised the prices of petroleum products to an unprecedented level in one single jump was the major cause for rise in prices during 1990-91. The prices of petrol and diesel are changed fortnightly according to the international prices of the crude oil.
SOME OTHER REASONS:
- When the government of a country print money in excess, prices increase to keep up with the increase in currency, leading to inflation.
- Increase in production and labor costs, have a direct impact on the price of the final product, resulting in the inflation.
CALCULATION OF INFLATION:
THERE ARE TWO METHODS OF CALCULATION OF INFLATION:
1) WPI (WHOLESALE PRICE INDEX)
2) CPI (CONSUMER PRICE INDEX)
India uses the wholesale price index method to calculate the inflation rate.
Developed countries use the consumer price index method to calculate the inflation rate.
WHOLESALE PRICE INDEX:
WPI is the index that is used to calculate the change in the average price level of goods traded in wholesale market. In India, a total of 435 commodities data on price level is estimated through WPI which is an indicator of movement in prices of commodities in all trade. It is also the price index which is available on a weekly basis with the shortest possible time gap of only two weeks. The Indian government has taken WPI as an indicator of the inflation rate in the economy.
CONSUMER PRICE INDEX:
CPI is a statistical time-series measure of a weighted average of prices of a specified group of goods and services purchased by consumers. It is a price index that tracks the prices of a specified set 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 a chosen point in time, so that all other values of the index are a percentage relative to this one.
India is the only major country which is using the WPI method to calculate inflation ,most other countries like Singapore, Germany, Japan etc uses the second method i.e. CPI method of calculating the inflation.
According to the economists CPI is the more correct method of calculating the inflation than WPI. This is because; a commodity like coarse grains is also considered while measuring inflation even though the commodity go into the making of feed of livestock and is insignificant.
Moreover 100 out of 435 commodities included in the list are nowadays not much important from the consumption point of view. Also WPI is used to calculate the impact on business but we use it to calculate its impact on consumers. In WPI many commodities included in the index are not even consumed by the consumers and they have not much importance in the economy.
RBI uses its monetary policy to achieve a judicious balance between growth of production and control of general price level. Bank uses CRR, Repo, Reverse repo and Bank rate to increase bank credit and expansion of business activity (in times of business recession) or to contract bank credit and check business (in periods of inflation).
INFLATION CAN ALSO BE CONTROLLED BY EMPLOYING SUPPLY MANAGEMENT:
This is related to the volume of supply and its distribution system. Increase in domestic supplies, large releases from official stocks of food grains and widening and streamlining of the network of public distribution are some govt. measures to prevent the increase in prices of essential commodities.
CONSEQUENCES OF INFLATON:
- If the balance between the demand and supply goes out of control, consumers will change their buying habits, forcing the manufacturers to cut down production.
- The mortgage crisis of USA in 2007 is the best example of the bad effects of inflation. Housing prices increases substantially, resulting in the decrease of their demand.
- Inflation can affect the low income household and result in increase of poverty.
- Manufacturers will not be able to control the cost of production and thus will also not be able to control the final product’s price.
- Producers would not find any incentive to invest money in acquiring new machinery and technology.
- People will draw money from banks due to uncertainty, and convert it gold as it has a long lasting value.