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Inflation: Causes, Effects and Measures

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Inflation: Causes, Effects and Measures

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General awareness on current topics is essential as not only you will be getting questions on GK in various MBA entrance exams but it will be useful for Essay writing test and WAT also. 
 
Today, you will read General Awareness Topic: “Inflation: Causes, Effects and Measures” 
 
A rise in general level of prices of goods and services in an economy over a period of time is referred as inflation. When the general price level rises, each unit of currency buys fewer goods and services.  Thus, inflation results in loss of value of money. The goods prices increase but the currency power remains unchanged which results in paying more for the same goods.
 
The inflation rate in India was recorded at 7.24 percent in November of 2012. Inflation Rate in India is reported by the Ministry of Statistics and Programme Implementation.
 
There are many intricate and complicated dynamics of economics that cause inflation. Some of the causes include misbalanced supply and demand, increase in production and distribution costs, increase in tax on goods and services, unstable political or economical environment etc. 
 
Other factors resulting in mismatch of demand and supply are  : 
 
• Over-expansion of money supply i.e. excess liquidity in the economy leads to inflation because “too many money would be chasing too few goods”.
• Rapid expansion of bank credit is also responsible for the inflationary trend in a country.
• The high doses of deficit financing which may cause reckless spending, may also contribute to the growth of the inflationary spiral in a country.
• A high population growth leads to increase in demand and money income and cause a high price rise.
• Excessive increase in the price of fuel or food products due to political, economic or natural reasons will lead to inflation for short- as well as long-term.
 
Inflation has the worst effect on the consumers. Since the price of commodities have increased, it becomes hard for the consumers to afford the basic commodities. The consumers have no choice but to ask for rise in wages which might not be possible. That is why government tries to decrease or control inflation. Whenever inflation increases, it is observed that many changes are introduced in the monetary and fiscal policies. Such changes do not bode well for the overall economic development of the economy. 
 
Other effects include: 
 
• People start consuming or buying less of these goods and services as their income is limited. This leads to slowdown not only in consumption but also production. Manufacturers will start producing fewer goods due to high costs and anticipated lower demand.
• Banks will increase interest rates as inflation increases otherwise real interest rate will be negative. (Real interest ~ Nominal interest rate – inflation). This makes borrowing costly for both consumers and corporate. Thus people will buy fewer automobiles, houses and other goods. Industries will not borrow money from banks to invest in capacity expansion because borrowing rates are high.
• Higher interest rates lead to slowdown in the economy. This leads to increase in unemployment because companies start focusing on cost cutting and reduces hiring. Remember Jet Airways lay off over 1000 employees to save cost.
• Rising inflation can prompt trade unions to demand higher wages, to keep up with consumer prices. Rising wages in turn can help fuel inflation.
• Inflation affects the productivity of companies. They add inefficiencies in the market, and make it difficult for companies to budget or plan long-term. Inflation can act as a drag on productivity as companies are forced to shift resources away from products and services in order to focus on profit and losses from currency inflation.
 
In order to tame the inflation, Reserve Bank of India and government are making continuous efforts to tame it. While RBI controls the liquidity in the economy by manipulating the interest rates, government tries to maintain the demand and supply balance through fiscal measures. The techniques of monetary policy influence the cost or availability of credit in general. But if the conditions in an economy are such that expansion in some directions is desirable even as credit in some fields needs to be curtailed, some degree of selectiveness must be introduced in monetary control.
 
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.). 
 
Other measures which can be undertaken by the government to curb inflation are   : 
 
• The limit of revenue account deficit
• Increase and develop industrial production to raise supply according to the demands.
• To increase industrial production, government liberalized laws related to and reduced prices of necessary raw materials and services.
• Too-grain is a factor, responsible for the rise of inflation in India, to fulfill its demand; various measures like import of wheat, oil seeds, opening market selling of India Food Corporation's stock of wheat and rice, regulating process etc. are taken in recent times.
• To check and curtail black market, laws have been made stringent. Black market while increases the unaccounted liquidity in economy, fiscal and monetary measures are also inapplicable on it. 
 
Moreover, poor must be protected and others must bear their fair share of the burden when the adjustments will be made both on the revenue side and on the expenditure side.
 
Inflation control in any developing country must be taken on priority basis as it is drag on development where incomes of the countrymen are not growing as fast. Measures to control must be holistic one including export, import, tax and other reform measures.   

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