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Inflation: Measures and Control

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Inflation: Measures and Control

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MBARendezvous.com -India's content lead MBA website  has started series of articles to equip MBA aspirants with general awareness with the hope that you would get success in various MBA entrance exams

Following article on” Inflation: Measures and Control ” is part of our series on general awareness:  

Inflation management is one of the hardest tasks an economic policymaker has to undertake. It is one of the most dreaded as well as one of the most misunderstood of economic phenomena. One needs a profound knowledge of statistical information and an in-depth understanding of economic theories to understand and control it. 

Inflation can have positive and/or negative effects on an economy. Negative effects of inflation could be a decrease in the real value of money and other monetary items over time; uncertainty about future inflation cal also discourage investment and savings, and high inflation might lead to shortages of goods if the consumers begin hoarding out of concern that the prices will increase in the future. Positive effects of inflation include a mitigation of economic recessions and debt relief by way of reducing the real level of debt.
 
Many economic factors cause inflation to rise in a country. It tends to rise when the Government of a country prints money in excess, then the prices increase to keep up with this increase in currency and this leads to inflation. An increase in production and labor costs has a direct impact on prices of the final product and this as well results in inflation.
High demands, when the number of goods and services produced are comparatively low, can also pull inflation. Costs push inflation or supply shock inflation is the situation, where the non availability of a commodity leads to increase in prices. 
 
Many a times, countries borrow money; in such case they also need to cope with the interest burden. This interest burden causes inflation. The high tax rates on consumer products can also result in inflation. Similarly, there are many other factors that cause inflation in the economy. 
 
Inflation in India is calculated as per Wholesale Price Index (WPI).  435 commodities are used for the WPI based inflation calculation and base year for the WPI calculation is 1993-94. The WPI is available at the end of every week (generally Saturdays), for a period of one year ended that day. 
 
There are broadly two ways of controlling inflation in an economy – Monetary measures and fiscal measures. 
 
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. It also includes - Bank Rate Policy, Cash Reserve Ratio (CRR) Operation and Open Market Operations.
 
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.
 
India is right now in the midst of an inflationary episode. It began in December 2009, when the WPI inflation climbed to 7.15%; it continued to rise, peaked in April 2010, at just short of 11%. Although after that, there was a broadly downward trajectory but it was disappointingly slow with a small pick-up in December 2011. But it did fall to a 25-month low of 6.55% WPI inflation for the Month of January 2012. But this is also not at an acceptable level and it should fall further. Both the government and Reserve Bank have taken a number of steps to address the issue of high inflation, including the reduction of import duty on essential commodities. 
 
The latest development on inflation is that now India will start releasing monthly Consumer Price Index (CPI) inflation data from February 21st, 2012, which will also capture price movement in the services sector, to provide internationally comparable data on retail prices. This stand was taken considering the fact that the price movement in the services sector, which constitutes around 55% of Indian economy, is not reflected in the WPI. 
 
The new CPI series will have 2010 as its base year and aims to provide retail price movements across rural and urban India. The series, which will cover retail prices in five major groups of food (a weightage of 49.71%), fuel & light (a weightage of 9.49%), clothing (a weightage of 4.73%), housing (a weightage of 9.77%) and education (a weightage of 26.31%), will provide a comprehensive reference point for policymakers. 
 
On 21st February 2012, India released first annual inflation rate, based on the consumer price index (CPI) for January 2012. The Central Statistics Office (CSO) data showed that inflation was at 7.65% for January 2012 on point to point basis (January 2012 over January 2011). According to CPI data released, rural retail inflation was at 7.38%, while the urban inflation rate for January was 8.25%. 
 
The inflation in Food and beverages group for the month stood at 4.11%, with 4.18% in rural area and 3.98% in urban areas. The data showed that inflation in Fuel and light group in January was at 13.13%, with 13.70% in rural India and 12.43% in urban areas.
 
The CPI data showed that inflation in the Clothing group was at 14.25%, with 13.78% in rural and 15.39% in urban areas. 
 
Within the food group, vegetable inflation was at -24.83%, fruits 10.62%, milk 16.53% and cereals 2.69%. 
 
After 13 policy rate hike since March 2010, the RBI paused the rate hike cycle and in its latest monetary policy cut the CRR by 25 basis points. India's GDP growth target has been revised downward to around 7% from earlier 8.4%.  
 
The popular measure of inflation based on Wholesale Price Index (WPI) will continue to exist along with the Consumer Price Index (CPI).
 
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