Types of Inflation & Measures to control the inflation - RBI Grade B Phase 2
Inflation can be defined as a “sustained rise in the general or overall level of prices of goods and services.” Thus, it can be understood that as inflation increases, every rupee you have buys a smaller percentage of goods or services i.e. value of money reduces or your purchasing power reduces. It is measured as an annual percentage increase.
Reasons of Inflation
Increase in Money supply
Increase in effective demand
Decreased effective supply or aggregate output
Types of Inflation
Cost Push Inflation
Cost-push inflation is a type of inflation that occurs when higher production costs (increase in the cost of wages, raw materials etc.) push up the prices of goods and services. The increased price of the factors of production leads to a decreased supply of these goods. While the demand remains constant, the prices of commodities increase causing a rise in the overall price level.
Demand Pull Inflation
Demand pull inflation can be defined as a type of inflation that occurs when price level increases due to a greater demand for goods or services than there is supply available. In other words, Demand-pull inflation occurs when aggregate demand for goods or services outstrips aggregate supply. These constituents of the economy demand more goods than can be produced by the economy. When supply cannot rise to meet demand, sellers will increase prices, thereby causing inflation.
Also called low or mild inflation, this type of inflation occurs when prices rise not more than 3% a year. It’s actually beneficial to economic growth. That’s because this mild inflation sets expectations that prices will continue to rise. As a result, it sparks increased demand as consumers decide to buy now before prices rise in the future. By increasing demand, mild inflation drives economic expansion.
This type of inflation occurs when price rises between 3-10% a year. It is harmful to the economy because it heats up economic growth too fast. People start to buy more than they need, just to avoid tomorrow’s much higher prices. This drives demand even further, so that suppliers can’t keep up. As a result, common goods and services are priced out of the reach of most people.
When inflation rises to ten percent or greater, it wreaks absolute havoc on the economy. Money loses value so fast that business and employee income can’t keep up with costs and prices. Foreign investors avoid the country, depriving it of needed capital. The economy becomes unstable, and government leaders lose credibility. Galloping inflation must be prevented.
Hyperinflation is when the prices of goods and services rise more than 50 percent a month. It is fortunately very rare. In fact, most examples of hyperinflation have occurred when the government printed money recklessly to pay for war. Examples of hyperinflation include Germany in the 1920s, Zimbabwe in the 2000s, and during the American Civil War.
Stagflation is when the economy experiences stagnant economic growth, high unemployment, and high inflation. It is unusual because policies to reduce inflation make life difficult for the unemployed, while steps to alleviate unemployment raise inflation.
This shows price rise in all goods and services except food and energy due to high prices fluctuations. Oil is a highly volatile commodity, with daily price variations. Food prices change based on gas prices (it heavily reflects on transportation costs) , which are directly linked to oil prices. As the government needs a fairly stable and true picture of inflation, core inflation is calculated.
This measure considers total inflation in an economy, including food and energy prices, which are more volatile.
Deflation is the reverse of inflation. It refers to a sustained decline in the price level of goods and services. It occurs when the annual inflation rate falls below zero percent (a negative inflation rate) , resulting in an increase in the real value of money. Japan suffered from deflation for almost a decade in 1990s.
Disinflation is a decrease in the rate of inflation, a slowdown in the rate of increase of the general price level of goods and services in a nation’s gross domestic product (GDP) over time.
Disinflation is distinct from deflation, a slow-down in the inflation rate, i.e. when inflation declines to a lower rate but is still positive.
Measures to Control the Inflation
There are broadly two ways of controlling inflation in an economy:
1) Monetary measures and
2) Fiscal measures
1) Monetary Measures
The most important and commonly used method to control inflation is monetary policy of the Central Bank. Most central banks use high interest rates as the traditional way to fight or prevent inflation.
2) Fiscal Measures
Fiscal measures to control inflation include taxation, government expenditure and public borrowings. The government can also take some protectionist measures (such as banning the export of essential items such as pulses, cereals and oils to support the domestic consumption, encourage imports by lowering duties on import items etc.)
Calculation of Inflation in India
Inflation is usually measured based on certain indices. Broadly, there are two categories of indices for measuring inflation i.e., wholesale prices and consumer prices.
Wholesale Price Index (WPI)
It is the index that is used to measure the change in the average price level of goods traded in wholesale market.
Wholesale Price Index (WPI) is computed by the Office of the Economic Adviser in Ministry of commerce & Industry, Government of India.
Current WPI Base year is 2004-05. There are total 676 items in WPI and inflation is computed taking 5482 Price quotations.
Consumer Price Index (CPI)
Consumer Price Index (CPI) considers consumer or retail prices of goods. Earlier, there were four major segments of CPI, namely for industrial, agricultural and rural labourers and urban non-manual employees (UNME) . However, since January 2011, only urban household and rural household-linked CPI is calculated by the Central Statistics Office (CSO) in the Ministry of Statistics and Programme Implementation.
Base year for CPI is 2012. The number of items in CPI basket include 448 in rural and 460 in urban.
The Wholesale Price Index (WPI) was main index for measurement of inflation in India till April 2014 when RBI adopted new Consumer Price Index (CPI) (combined) i.e. CPI (rural) and CPI (urban) as the key measure of inflation.
Note-The RBI adopted consumer price-based inflation at 4% with a tolerance of ± 2% till March, 2021 under the monetary policy framework.