MCom I Semester Managerial Economics Inflation Study Material Notes
Table of Contents
MCom I Semester Managerial Economics Inflation Study Material Notes: Meaning and Definition of Inflation Causes of Inflation Increase in Money Income Low Production Effects on Inflation Effects on Production Effects on Distribution Measures to Check Inflation Monetary Measures Fiscal Measures Other Measures :
MCom I Semester Statistical Analysis Simulation Study Material Notes
INFLATION
MEANING AND DEFINITION OF INFLATION
Inflation in the popular mind is generally associated with rapidly rising prices which cause a decline in the purchasing power of money. Different economists have defined Inflation as follows
Crowther, “Inflation is a stage in which value of money is falling i.e.. prices are rising.”
Webester, “Inflation is a stage when value of money and credit relative to available goods resulting in a substantial and continuing in the general price-level.”
Hawtrey, “The stage in which there is over issue of currency is called Inflation.”
According to these definitions, the rise of prices is caused by an increase in the supply of money. The increase in the supply of money is the cause, the rise in the price-level is the effect.
But sometimes the rise in the price-level instead of being the result becomes actually the cause of the expansion of money supply as was the case of Germany after the First World War. In Germany, it was, then, the rise in prices which caused the expansion of money supply in Germany. In the words of Einzig, “Inflation is that state of disequilibrium in which an expansion of purchasing power tends to cause or to be the effect on an increase in the price-level.” An analysis of this definition reveals the fact that the rise in the price-level is not only the result but also the cause of the expansion of money supply.
CUSES OF INFLATION
Increase in money income and low production are in main two factors responsible for inflation. These can be described as follows:
(I) INCREASE IN MONEY INCOME
Following are the factors that help increase money income
1 Government Policy. When the government tides over the crisis in the country through printing of fresh notes, the quantity of money exceeds its requirement and inflationary conditions are thereby created.
2. Credit Policy of Bank. The Central Bank’s policy of rate of interest and purchase and sale of securities in the open market affects the amount of credit. If the bank lowers the rate of interest, it will lead to increase in the demand of loan which creates inflation. Similarly, when bank increases currency in the open market by purchasing securities it again results in inflation.
3. Deficit Financing. When government resorts to deficit financing to meet its budget deficit, it creates inflationary condition in the country.
4. Increase in Velocity. The velocity of money affects the supply side of money which encourages inflation by rising the prices of goods and services.
5. Natural Factors. Sometimes, inflation stems from natural factors, such as-famines, earthquakes, floods, hailstorms etc., in the country.
(II) LOW PRODUCTION
The following factors account for low production in the country
1 Increase in Population. According to the population theory of Malthus, the increase in production is not in proportion to increase in population which increases at a faster rate than production and this situation encourages inflation.
2. Taxation Policy. When the government devietaxes or increases the amount of old taxes, it only increases the price of goods and services and consequently reduces the demand and production both.
3. Trade Policy of Government. When the government encourages export with a view to earn foreign exchange, it follows with an increase in the price of goods in the country.
4. Inefficiency of Administration. Unnecessary boarding of goods, profiteering and bribery become rampant consequent upon mal-administration in the country and traders and producers thus succeed in creating artificial shortage of goods in the country.
5. Industrial Unrest. As a result of dispute between labour and capital, lockout and strikes soon follow and the production process comes to a halt. It leads to shortage of goods which encourages inflation in the country.
6. Technological Change. The process of production suffers sometimes due to technological change in industries. During this period, inflation comes into being.
7. Growth in Population. When population increases at a rate faster than that of production, a disequilibrium follows which creats inflationary conditions in the country.
EFFECTS ON INFLATION
The effects of inflation can be discussed under two sub- heads : (I) Effects on Production, and (II) Effects on Distribution. Details regarding these are as follows:
(1) EFFECTS ON PRODUCTION
An expansion of money supply up to the point of full employment may not be harmful for the economy. In fact, mild inflation may even serve as a topic for the economy of the country. But an expansion of money supply after the point of full employment will degenerate into runaway or hyper inflation and thus is very harmful for the economy of a country. In fact, hyper-inflation disrupts the smooth functioning of the economy. It is this hyper-inflation which was harmful consequences for the economy. It is this hyper-inflation which has harmful cansequences for the economy. This type of inflation has the following adverse effects on the productive activities of the country,
1 Discouragement to Savings. Since hyper-inflation result in a serious depreciation of the value of money, it discourages savings on the part of the public with the result that process of capital formation suffers a serious set-back.
2. Set-back to Investment. With reduced capital accumulation, the investment will suffers a serious set-back which may have an adverse effect on the volume of production in the country. The volume of production will not only decline on the account of the slowing down of capital accumulation, it may also decline on account of business uncertainty which may discourage enterpreneurs from taking business risks in production.
3. Serious Deterioration in the Quality of Goods Produced. Since runaway inflation results in a seller’s market, it may lead to a serious deterioration in the quality of goods produced in the economy.
4. Hoarding of Essential Goods. Inflation also leads to hoarding of essential goods both by the traders as well as the consumers. The traders hoard stocks of essential com e s with a view to earn higher profits or, with a view to sell scarce items in the black market.
5. Stimulus to Speculation. Instead of earning increased profits out of increased production, the businessmen find it easier to increase their profits through speculative activities.
6. Flight from Domestic Currency. The worst effect of hyper-inflation is that, in course of time, it results in a flight from domestic currency account of its constantly diminishing value. In an advanced stage of hyper-inflation, the people lose confidence in their home currency and rush to buy foreign currency of stabler value to safeguard their interests.
Inflation Study Material Notes
(II) EFFECTS ON DISTRIBUTION
There is always a time lag between the rise in production costs and the rise in the price-level. This time lag brings rich profit to the business classes. In other words, flexible income groups, such as—businessmen, industrialists merchants, etc., are always the gainers in a period of inflation, while the fixed income groups, such as the workers and the salaried employees are always the losers on account of the inflationary rise in prices. The concrete effects of inflation on various groups of society are as follows
1 Debtors and Creditors. During inflation, debtors are generally the gainers while creditors are the losers. The debtors while repaying the debts return less purchasing power to the creditors than what they had actually borrowed. Since the creditors receive loss in real terms, they are the losers during inflation.
2. Wages and Salary Earners. Wages and salary earners mostly suffer during inflation, because wages and salaries generally do not rise in the same proportion in which the cost of living rises.
3. Producers. Inflation is a boon to the producers because it serves as a tonic for business enterprises. They experience windfall gains as the prices of their stocks suddenly go up.
4. Investors. Investors are generally of two types–(i) Investors in equities (shares), and (ii) Investors in fixed interest yielding bonds and debentures. Inflation bestows favours on the former and is rather harsh on the latter. Dividends on equities increase in prices and corporate earnings, and as such the investors in equities are favourable affected, income from bonds and debentures, however, remains fixed and as such investors in them are adversely affected.
5. Farmers. Farmers are generally the gainers during inflation. The prices of farm products go up while the costs incurred by them do not go up to the same extent. There is generally a time lag between the rise in prices and the increase in costs. Moreover, the farmers are generally debtors and can repay their debts during inflation in terms of less purchasing power.
Thus, we can say that inflation is most unjust and iniquitous. It transfers wealth’to those sections which have already too much of it.
MEASURES TO CHECK INFLATION
There are three lines of action to check and contains inflation boom, namely—(1) Monetary Measures. (II) Fiscal Measures, (III) Other Measures. Details regarding these are as follows
(1) MONETARY MEASURES
It is best of the measures to check inflation through adopting monetary measures. Central Bank is required to control the quantity of money in the country. Following are the monetary measures which can be used to curb inflationary pressures—
1 Increased Re-discount Rate. To curb inflation, the Central Bank generally increases the re-discount rate leading to an increase in bank rates which tend to discourage borrowing by businessmen from banks, resulting in a fall in the intensity of inflationary pressures in the economy. Savings will be attractive than before and induce people to spend less on consumer goods.
2.Sale of Government Securities in the Open Market. Another method to check the inflationary boom is to resort to sale of government securities to the public by the bank. As the buying public purchases and pays for those government Securities, the commercial bank’s reserves with the Central Bank are correspondingly reduced and they are obliged to adopt a restrictionist credit policy in relation to business requirements.
3. Higher Reserve Requirements. An increase in reserve requirements of the members bank also serves as an anti-inflationary weapon during! inflation. It absorbs the excess reserves of the banking system and thus, prevents them from forming a basis for further credit expansion.
4. Higher Margin Requirements. The higher margin requirements, the the amount of loan that the borrower can obtain from the bank. Thus. ments have the effect of checking undue monetary higher margin requirements have the effect of checking expansion
Inflation Study Material Notes
(II) FISCAL MEASURES
The major anti-inflationary fiscal measures are the following
1 Taxation. The rates of existing taxes should be steeply increased while new taxes should be imposed on commodities so as to leave less money supply with the public to spend.
2. Public Borrowing. The object of public borrowing is to take away from the public excess purchasing power. If voluntary borrowing does not yield adequate results, it may become necessary to resort to compulsory borrowing from the public.
3. Debt Management. The idea of debt management is the government securities held by commercial banks should be retired by the government out of the budgetary surplus. This would check the powers of the commercial banks to encash their securities and add to the reserves for the purspose of credit expansion.
4.Government Expenditure. To counteract increased private spending at a time of inflation, the government should, at such a time, reduce its own expenditure to the minimum extent possible to help limit the aggregate demand.
5. A Suitable Price Income Policy. At a time of inflation, the government must also adopt a suitable price income policy. It should strictly control wages, salaries and profits to keep standing at a low level to fight inflation
(III) OTHER MEASURES
Following other measures can be used to supplement monetary and fiscal measures undertaken to contain inflationary pressures—
1 Expansion of Output. Inflation arises partly due to inadequacy of output. A re-allocation of productive resources is suggested to step up the output of inflation-sensitive goods, such as-food, clothing, housing, etc. Steps may also be taken to increase supply of consumer goods through large-scale imports from other countries to absorb excess money supply.
2. Wage Policy. Wage increases may be allowed to workers only if their productivity increases. If this priciple is observed, higher wages shall not lead to higher unit cost and hence, there will be restriction on higher unit prices.
3. Price Control and Rationing. The object of price control is to lay down the upper limit beyond which the price of a particular commodity would not be allowed to rise. To ensure the successful functioning of price control, following two conditions will have to be satisfied:
(i) The government should have under its control adequate stocks of the commodities concerned.
(ii) The demand for the concerned commodities should be controlled through rationing, failing which the richer sections shall be able to buy a major portion of the available stocks.
