Why in news?
India’s retail inflation eased sharply to 6.77 per cent on an annual basis in the month of October 2022.
- The decline in headline inflation can be attributed to favourable base effect.
- The supply-chain disruptions due to ongoing geopolitical factors and hardening of commodity prices globally continue to thrust ahead the inflationary pressure.
- The number has remained above RBI’s tolerance band of 2-6 per cent for the 10th consecutive month.
What is Inflation?
- Inflation is a rise in prices, which can be translated as the decline of purchasing power over time.
- The rate at which purchasing power drops can be reflected in the average price increase of a basket of selected goods and services over some period of time.
- The rise in prices, which is often expressed as a percentage, means that a unit of currency effectively buys less than it did in prior periods
What Causes Inflation ?
- An increase in the supply of money is the root of inflation, though this can play out through different mechanisms in the economy
- Printing and giving away more money to citizens
- Legally devaluing (reducing the value of) the legal tender currency
- Loaning new money into existence as reserve account credits through the banking system by purchasing government bonds from banks on the secondary market (the most common method)
In all of these cases, the money ends up losing its purchasing power.
What are the types of inflation?
- Demand-pull inflation: It refers to situations where there are not enough products or services being produced to keep up with demand, causing their prices to increase.
- Cost-push inflation: It occurs when the cost of producing products and services rises, forcing businesses to raise their prices.
- Built-in inflation: It occurs when workers demand higher wages to keep up with rising living costs. This in turn causes businesses to raise their prices in order to offset their rising wage costs, leading to a self-reinforcing loop of wage and price increases. (which is sometimes referred to as a wage-price spiral)
What are the types of Price Indexes?
The Consumer Price Index (CPI): Examines the weighted average of prices of a basket of goods and services of primary consumer needs. They include transportation, food, and medical care.
- The prices in consideration are the retail prices of each item, as available for purchase by the individual citizens.
- Released: National Statistical Office (NSO).
- Base Year : 2012
Four types of CPI are as follows:
- CPI for Industrial Workers (IW) – Labour Bureau
- CPI for Agricultural Labourer (AL) – Labour Bureau
- CPI for Rural Labourer (RL) – Labour Bureau
- CPI (Rural/Urban/Combined) – NSO, Ministry of Statistics and Programme Implementation.
- Reserve Bank of India (RBI) had adopted the CPI as its key measure of inflation.
The Wholesale Price Index (WPI): It measures and tracks the changes in the price of goods in the stages before the retail level. While WPI items vary from one country to other, they mostly include items at the producer or wholesale level.
- Released: Office of Economic Adviser, Ministry of Commerce and Industry
- Base year: 2011-12
What are the advantages of Inflation?
- Individuals with assets like property or stocked commodities priced in their home currency raises the price of their assets, which they can sell at a higher rate.
- It may increase spending, which may boost economic activities in a country.
- With cost and demand of goods goes up and consumers purchase will increase . This tend to push their employers for higher wages. In order to remain competitive, employers have to continually offer higher wages.
What are major disadvantages of Inflation ?
- If inflation is high, that means the cost of products tends to be higher. This can make a country very uncompetitive with others around the world with higher value for money
- With hyperinflation leads to less investment. People choose instead to hold onto cash in a savings account that reduces investment in machinery and other things that are used to create products.
- Inflation does drive up some prices first and drives up other prices later. This sequential change in purchasing power and prices distorts relative prices, wages, and rates of return along the way
What are ways to control inflation?
Monetary Policy Tools:
- Cash Reserve Ratio (CRR) – Banks are required to set aside this portion in cash with the RBI.
- Statutory Liquidity Ratio (SLR) – Banks are required to set aside this portion in liquid assets such as gold or RBI approved securities such as government securities.
- Open Market Operations (OMO): In order to control money supply, the RBI buys and sells government securities in the open market. The objective of OMOs are to keep a check on temporary liquidity mismatches in the market, owing to foreign capital flow.
Market Stabilisation Scheme (MSS) –
- Bank rate – The interest rate at which RBI lends long term funds to banks is referred to as the bank rate.
Liquidity Adjustment Facility (LAF) –
- Repo rate: Repo rate is the rate at which banks borrow from RBI on a short-term basis against a repurchase agreement. Banks are required to provide government securities as collateral and later buy them back after a pre-defined time.
- Reverse Repo rate: It is the reverse of repo rate, i.e., this is the rate RBI pays to banks in order to keep additional funds in RBI.
- Marginal Standing Facility (MSF) Rate: MSF Rate is the penal rate at which the Central Bank lends money to banks, over the rate available under the rep policy. Banks availing MSF Rate can use a maximum of 1% of SLR securities.
Fiscal Measures :By Government
- Reduction in Unnecessary Expenditure: Government should reduce unnecessary expenditure on non-development activities in order to curb inflation.
- Increase in Taxes: To cut personal consumption expenditure, the rates of personal, corporate and commodity taxes should be raised and even new taxes should be levied,
- Increase in Savings: This will tend to reduce disposable income with the people the government should float public loans carrying high rates of interest, start saving schemes with prize money, or lottery for long periods, etc. It should also introduce compulsory provident fund, provident fund-cum-pension schemes, etc. All such measures increase savings and are likely to be effective in controlling inflation.
- Surplus Budgets: It means collecting more in revenues and spending less.
- Public Debt: It should stop repayment of public debt and postpone it to some future date till inflationary pressures are controlled within the economy. Instead, the government should borrow more to reduce money supply with the public