Inflation measures undertaken by Govt.

& its effect

Inflation measures undertaken by Govt. & its effect

Introduction:Inflation is a rise in general level of prices of goods and services over time. Although "inflation" is sometimes used to refer to a rise in the prices of a specific set of goods or services, a rise in prices of one set (such as food) without a rise in others (such as wages) is not included in the original meaning of the word. Inflation can be thought of as a decrease in the value of the unit of currency. It is measured as the percentage rate of change of a price index but it is not uniquely defined because there are various price indices that can be used. Many economists believe that high rates of inflation are caused by high rates of growth of the money supply.Views on the factors that determine moderate rates of inflation are more varied: changes in inflation are sometimes attributed to fluctuations in real demand for goods and services or in available supplies (i.e. changes in scarcity), and sometimes to changes in the supply or demand for money. In the mid-twentieth century, two camps disagreed strongly on the main causes of inflation at moderate rates: the "monetarists" argued that money supply dominated all other factors in determining inflation, while "Keynesians" argued that real demand was often more important than changes in the money supply. There are many measures of inflation. For example, different price indices can be used to measure changes in prices that affect different people. Two widely known indices for which inflation rates are reported in many countries are the Consumer Price Index (CPI), which measures consumer prices, and the GDP deflator, which measures price variations associated with domestic production of goods and services.

Inflation measures undertaken by Govt. & its effect

Related Definitions:Related economic concepts include: deflation, a general falling in price level; disinflation, a decrease in the rate of inflation; hyperinflation, an out-of-control inflationary spiral; stagflation, a combination of inflation and slow economic growth and rising unemployment; and reflation, which is an attempt to raise prices to counteract deflationary pressures. In classical political economy, inflation meant increasing the money supply, while deflation meant decreasing it (see monetary inflation). Economists from some schools of economic thought (including some Austrian economists) still retain this usage. In contemporary economic terminology, these would usually be referred to as expansionary and contractionary monetary policies.

WHY IS HIGH?

INFLATION

SO

The immediate cause for the big jump is the recent hike in petroleum product prices. But Inflation has been building for some time due to the increase in food, steel and cements prices, among other things. The big increase in money supply due to external inflows last year was another contributory cause.

Inflation measures undertaken by Govt. & its effect

Inflation tackle it:-

in

India:

How

to

Inflation is no stranger to the Indian economy. In fact, till the early nineties Indians were used to double-digit inflation and its attendant consequences. But, since the mid-nineties controlling inflation has become a priority for policy framers. The natural fallout of this has been that we, as a nation, have become virtually intolerant to inflation. While inflation till the early nineties was primarily caused by domestic factors (supply usually was unable to meet demand, resulting in the classical definition of inflation of too much money chasing too few goods), today the situation has changed significantly. Inflation today is caused more by global rather than by domestic factors. Naturally, as the Indian economy undergoes structural changes, the causes of domestic inflation too have undergone tectonic changes. Needless to emphasize, causes of today's inflation are complicated. However, it is indeed intriguing that the policy response
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Inflation measures undertaken by Govt. & its effect

even to this day unfortunately has been fixated on the traditional antiinflation instruments of the pre-liberalization era.

Inflation Predictions:Predicting inflation is a very important task for Economists. Future forecasts of inflation are used to determine current monetary policy. If inflation predictions are wrong it can cause inappropriate monetary policy, resulting in either inflation or recession. Although economists may look at various economic data, there is no foolproof method for predicting inflation. Generally speaking inflation is easier to predict and less volatile when inflation rates are low. As inflation increases it also becomes more volatile and harder to predict. 1. Predicting Inflation:To predict inflation, economists will need to look at various economic data and decide whether inflationary pressures in the economy will be increasing or decreasing. The key factor here is the amount of spare capacity and the rate of economic growth. Suppose an economy, such as the UK, has a long run trend rate of 2.5%. This means growth of 2.5% or less is
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Inflation measures undertaken by Govt. & its effect

unlikely to cause inflation. If however, growth is above 3 -4 % then the economy will quickly approach full capacity and therefore inflation is likely to occur. 2. Unemployment And Inflation Prediction:Some economists believe there is a trade off between unemployment and inflation. If unemployment falls it could be a sign that inflationary pressures will increase. As unemployment falls it gets harder to employ workers causing wage inflation. This wage inflation is likely to cause actual inflation. However, sometimes unemployment can fall without causing inflation. For example, unemployment has fallen in the UK, without causing inflation. This may be due to a sustained reduction in the natural rate (structural unemployment) Nevertheless unemployment figures can be a guide to future inflation. 3. House Prices and Future Inflation:It is often assumed that house price inflation will cause actual inflation. There is a good economic reason for this. If house prices are rising it creates a wealth effect. Rising wealth encourages consumer spending (equity withdrawal and higher confidence) this spending can then cause inflation. However, it doesnt necessarily cause inflation. In the early 2000s, the UK had house price inflation of over 20%, but it didnt cause actual inflation. There are many factors that affect inflation, not just house prices. 4. Money Supply and Inflation:The quantity theory of money states that increased money supply will lead to inflation. This is because of the
6

Inflation measures undertaken by Govt. & its effect

relationship between money supply and inflation, shown in the equation MV=PT where V and T are independent of the Money Supply. However, in practice empirical evidence has shown that increased money supply doesnt necessarily cause inflation, as there are other factors determining money supply and inflation. 5. Hysteresis - What Happened in the Past? It is argued that if you want the best prediction for inflation, ignore all the economists predictions and just state what happened last year. E.g. in 2007 the UK experienced inflation of 2.1%. Therefore the best prediction for inflation in 2007 is 2.1%. Of course, inflation does change from year to year, but it shows the difficulty of predicting inflation that it is often best to just use last years data. However, there is an important point here and that is the role of expectations. If inflation is low, people will expect low inflation in the next year, workers will not demand big pay rises, firms will not try to increase prices. Therefore, low inflation becomes easier to maintain. If inflation is high then people will be expecting inflation in the next year. Therefore, it becomes difficult to remove inflation from the system (without pain like a recession) 6. Supply Side Shocks and Inflation:When predicting inflation you can never take into account unexpected supply side shocks. For example, a rapid increase in inflation would cause a significant rise in inflation.

Inflation measures undertaken by Govt. & its effect

INFLATION: MEASURED?

HOW

IS

IT

Measuring inflation is a difficult problem for government statisticians. To do this, a number of goods that are representative of the economy are put together into what is referred to as a "market basket." The cost of this basket is then compared over time. This results in a price index, which is the cost of the market basket today as a percentage of the cost of that identical basket in the starting year. There are two main price indexes that measure inflation:
Consumer Price Index (CPI) - A measure of price changes in

consumer goods and services such as gasoline, food, clothing and automobiles. The CPI measures price change from the perspective of the purchaser. U.S. CPI data can be found at the Bureau of Labor Statistics. the average change over time in selling prices by domestic producers of goods and services. PPIs measure price change from the perspective of the seller. U.S. PPI data can be found at the
8

Producer Price Indexes (PPI) - A family of indexes that measure

Inflation measures undertaken by Govt. & its effect

Bureau of Labor Statistics. You can think of price indexes as large surveys. Each month, the U.S. Bureau of Labor Statistics contacts thousands of retail stores, service establishments, rental units and doctors' offices to obtain price information on thousands of items used to track and measure price changes in the CPI. They record the prices of about 80,000 items each month, which represent a scientifically selected sample of the prices paid by consumers for the goods and services purchased. In the long run, the various PPIs and the CPI show a similar rate of inflation. This is not the case in the short run, as PPIs often increase before the CPI. In general, investors follow the CPI more than the PPIs.

Measures of inflation:Inflation is measured by calculating the percentage rate of change of a price index, which is called the inflation rate. This rate can be calculated for many different price indices, including: 1) Consumer price indices (CPIs):- which measure the price of a selection of goods purchased by a "typical consumer." In the UK, an alternative index called the Retail Price Index (RPI) uses a slightly different market basket.

2) Cost-of-living indices (COLI) are indices similar to the CPI which are often used to adjust fixed incomes and contractual incomes to maintain the real value of those incomes.

Inflation measures undertaken by Govt. & its effect

3) Producer price indices (PPIs) which measure the prices received by producers. This differs from the CPI in that price subsidization, profits, and taxes may cause the amount received by the producer to differ from what the consumer paid. There is also typically a delay between an increase in the PPI and any resulting increase in the CPI. Producer price inflation measures the pressure being put on producers by the costs of their raw materials. This could be "passed on" as consumer inflation, or it could be absorbed by profits, or offset by increasing productivity. In India and the United States, an earlier version of the PPI was called the Wholesale Price Index.

4) Commodity price indices, which measure the price of a selection of commodities. In the present commodity price indices are weighted by the relative importance of the components to the "all in" cost of an employee.

5) The GDP Deflator is a measure of the price of all the goods and services included in Gross Domestic Product (GDP). The US Commerce Department publishes a deflator series for US GDP, defined as its nominal GDP measure divided by its real GDP measure.

6) Capital goods price Index, although so far no attempt at building such an index has been made, several economists have recently pointed out the necessity of measuring capital goods inflation (inflation in the price of stocks, real estate, and other assets) separately. Indeed a given increase in the supply of money can lead to a rise in inflation (consumption goods inflation) and or to a rise in capital goods price inflation. The growth in money supply has remained fairly constant through since the 1970s however consumption goods price inflation has been reduced because most of the inflation has happened in the capital goods prices.
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Inflation measures undertaken by Govt. & its effect

Other types of inflation measures include:

Regional Inflation The Bureau of Labor Statistics breaks down CPI-U calculations down to different regions of the US. Historical Inflation Before collecting consistent econometric data became standard for governments, and for the purpose of comparing absolute, rather than relative standards of living, various economists have calculated imputed inflation figures. Most inflation data before the early 20th century is imputed based on the known costs of goods, rather than compiled at the time. It is also used to adjust for the differences in real standard of living for the presence of technology. This is equivalent to not adjusting the composition of baskets over time. Fiscal measures Chidambaram said fiscal, monetary and administrative steps taken by the RBI and the government have contained inflation. There are many other countries, which are not able to contain inflation at this level due to one or the other reason, he added. The Finance Minister once again said that the cement manufacturers have a scope to cut prices. I maintain that there is scope for cement manufacturers to cut prices, new capacities have been added, there is no reason why they cannot afford to cut prices, he noted. Following government intervention, companies have already announced Rs3 to Rs7.5 reduction in a cement bag of 50 kg. Prices of food articles like fruits and vegetables, spices, coffee, masoor rose, compounding worries of the government and RBI amid a slowdown in industrial growth.

Issues in measuring inflation:Measuring inflation requires finding objective ways of separating out changes in nominal prices from other influences related to real activity. In the simplest possible case, if the price of a 10 oz. can of corn changes from $0.90 to $1.00 over the course of a year, with no change in quality, then this price change represents inflation. But we are usually more interested in knowing how the overall cost of living changes, and therefore instead of looking at the change in price of one
11

Inflation measures undertaken by Govt. & its effect

good, we want to know how the price of a large 'basket' of goods and services changes. This is the purpose of looking at a price index, which is a weighted average of many prices. The weights in the Consumer Price Index, for example, represent the fraction of spending that typical consumers spend on each type of goods (using data collected by surveying households). Inflation measures are often modified over time, either for the relative weight of goods in the basket, or in the way in which goods from the present are compared with goods from the past. This includes hedonic adjustments and reweighing as well as using chained measures of inflation. As with many economic numbers, inflation numbers are often seasonally adjusted in order to differentiate expected cyclical cost increases, versus changes in the economy. Inflation numbers are averaged or otherwise subjected to statistical techniques in order to remove statistical noise and volatility of individual prices. Finally, when looking at inflation, economic institutions sometimes only look at subsets or special indices. One common set is inflation excluding food and energy, which is often called core inflation.

Effects of inflation:-

A small amount of inflation can be viewed as having a beneficial effect on the economy.[3] One reason for this is that it can be difficult to renegotiate prices and wages. With generally increasing prices it is easier for relative prices to adjust. Many prices are "sticky downward" and tend to creep upward, so that efforts to attain a zero inflation rate (a constant price level) punish other sectors with falling prices, profits, and employment. Efforts to attain complete price stability can also lead to deflation, which is generally viewed as a negative by Keynesians because of the downward adjustments in wages and output that are associated with it.

12

Inflation measures undertaken by Govt. & its effect

With inflation, the price of any given good is likely to increase over time, therefore both consumers and businesses may choose to make purchases sooner rather than later. This effect tends to keep an economy active in the short term by encouraging spending and borrowing, and in the long term by encouraging investments. But inflation can also reduce incentives to save, so the effect on gross capital formation in the long run is ambiguous. Inflation is also viewed as a hidden risk pressure that provides an incentive for those with savings to invest them, rather than have the purchasing power of those savings erode through inflation. In investing, inflation risks often cause investors to take on more systematic risk, in order to gain returns that will stay ahead of expected inflation. Inflation also gives central banks room to maneuver, since their primary tool for controlling the money supply and velocity of money is by setting the lowest interest rate in an economy - the discount rate at which banks can borrow from the central bank. Since borrowing at negative interest is generally ineffective, a positive inflation rate gives central bankers "ammunition", as it is sometimes called, to stimulate the economy. As central banks are controlled by governments, there is also often political pressure to increase the money supply to pay government services, this has the added effect of creating inflation and decreasing the net money owed by the government in previously negotiated contractual agreements and in debt. For these reasons, many economists see moderate inflation as a benefit; some business executives see mild inflation as "greasing the wheels of commerce."[4][5] But other economists have advocated reducing inflation to zero as a monetary policy goal particularly in the late 1990s at the end of a long disinflationary period, when the policy seemed within reach; and some have even advocated deflation instead of inflation. In general, high or unpredictable inflation rates are regarded as bad:

Uncertainty about future inflation may discourage investment and saving.

13

Inflation measures undertaken by Govt. & its effect

Redistribution o Rent Seeking - happens when resources are used to merely transfer wealth rather than produce it. e.g. a company tries to gauge and combat the costs of inflation. o Inflation redistributes income from those on fixed incomes, such as pensioners, and shifts it to those who draw a variable income, for example from wages and profits which may keep pace with inflation. o Debtors may be helped by inflation due to reduction of the real value of debt burden. o Inflation redistributes wealth from those who lend a fixed amount of money to those who borrow. For example, where the government is a net debtor, as is usually the case, it will reduce this debt redistributing money towards the government. Thus inflation is sometimes viewed as similar to a hidden tax. o A particular form of inflation as a tax is Bracket Creep (also called fiscal drag). By allowing inflation to move upwards, certain sticky aspects of the tax code are met by more and more people. For example, income tax brackets, where the next dollar of income is taxed at a higher rate than previous dollars, tend to become distorted. Governments that allow inflation to "bump" people over these thresholds are, in effect, allowing a tax increase because the same real purchasing power is being taxed at a higher rate. International trade: Where fixed exchange rates are imposed, higher inflation than in trading partners' economies will make exports more expensive and tend toward a weakening balance of trade. Shoe leather costs: Because the value of cash is eroded by inflation, people will tend to hold less cash during times of inflation. This imposes real costs, for example in more frequent trips to the bank. (The term is a humorous reference to the cost of replacing shoe leather worn out when walking to the bank.) Menu costs: Firms must change their price more frequently, which imposes costs, for example with restaurants having to reprint menus.
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Inflation measures undertaken by Govt. & its effect

Relative Price Distortions: Firms do not generally synchronize adjustment in prices. If there is higher inflation, firms that do not adjust their prices will have much lower prices relative to firms that do adjust them. This will distort economic decisions, since relative prices will not be reflecting relative scarcity of different goods. Rising inflation can prompt trade unions to demand higher wages, to keep up with consumer prices. Rising wages in turn can help fuel inflation. In the case of collective bargaining, wages will be set as a factor of price expectations, which will be higher when inflation has an upward trend. This can cause a wage spiral. In a sense, inflation begets further inflationary expectations. Hoarding: people buy consumer durables as stores of wealth in the absence of viable alternatives as a means of getting rid of excess cash before it is devalued, creating shortages of the hoarded objects. Hyperinflation: if inflation gets totally out of control (in the upward direction), it can grossly interfere with the normal workings of the economy, hurting its ability to supply.

Controlling inflation:There are a number of methods that have been suggested to control inflation. Central banks such as the U.S. Federal Reserve can affect inflation to a significant extent through setting interest rates and through other operations (that is, using monetary policy). High interest rates and slow growth of the money supply are the traditional ways through which central banks fight or prevent inflation, though they have different approaches. For instance, some follow a symmetrical inflation target while others only control inflation when it rises above a target, whether express or implied. Monetarists emphasize increasing interest rates (slowing the rise in the money supply, monetary policy) to fight
15

Inflation measures undertaken by Govt. & its effect

inflation. Keynesians emphasize reducing demand in general, often through fiscal policy, using increased taxation or reduced government spending to reduce demand as well as by using monetary policy. Supply-side economists advocate fighting inflation by fixing the exchange rate between the currency and some reference currency such as gold. This would be a return to the gold standard. All of these policies are achieved in practice through a process of open market operations. Another method attempted in the past have been wage and price controls ("incomes policies"). Wage and price controls have been successful in wartime environments in combination with rationing. However, their use in other contexts is far more mixed. Notable failures of their use include the 1972 imposition of wage and price controls by Richard Nixon. In general wage and price controls are regarded as a drastic measure, and only effective when coupled with policies designed to reduce the underlying causes of inflation during the wage and price control regime, for example, winning the war being fought. Many developed nations set prices extensively, including for basic commodities as gasoline. The usual economic analysis is that that which is under priced is over consumed, and that the distortions that occur will force adjustments in supply. For example, if the official price of bread is too low, there will be too little bread at official prices. Temporary controls may complement a recession as a way to fight inflation: the controls make the recession more efficient as a way to fight inflation (reducing the need to increase unemployment), while the recession prevents the kinds of distortions that controls cause when demand is high. However, in general the advice of economists is not to impose price controls but to liberalize prices by assuming that the economy will adjust and abandon unprofitable economic activity. The lower activity will place fewer demands on whatever commodities were driving inflation, whether labor or resources, and inflation will fall with total economic output. This often produces a severe recession, as productive capacity is reallocated and is thus often very unpopular with the people whose livelihoods are destroyed. The economy of Zimbabwe has evolved under unique circumstances almost three of all embracing controls and regulations (Ncube M 1998).The supply and demand imbalances which
16

Inflation measures undertaken by Govt. & its effect

characterized the economy in the first decade could easily have resulted in severe inflation/deterioration of balance of payment had it not been for the stringent interest rates, import and prices controls which had been a major feature of government policies.

Policies and Strategies implemented Government took measures such as the Draconian measures/policies that is tightening of money supply and foreign currency allocation procedures and the suspension of profit repatriation helped reduce inflation in the mid 1980s and the government also put up incentives to incentives to encourage exports e.g. the 1983 Export Revolving Fund (ERF) which was established to provide exporters with foreign currency for importing inputs that were for meeting verified export orders. To encourage agricultural production, producer prices were raised this increased GDP FROM 2.6% in 1984 to 7.5% in 1985 and thus money supply expansion decreased from 22.3% in 1984 to 4.2% in 1985 and thus pushed inflation down to 10% from 19% in 1984 and also the interest rates adjusted downwards, farm mechanization was also put in place as part of the government efforts to revive the agricultural sector which was the backbone of the economy, it also introduced the Agricultural special production enhancement facility (ASPEF) to help distressed and new farmers attain finance and loans. The government also embarked in a drive to commercialize and privatise loss making enterprises and rationalization of the civil service and a number of companies got commercialized such as the Cold Storage Commission, Dairy Marketing Board and the Cotton Marketing Board and this helped reduce inflation. Stringent import controls and quotas were used to curb excess demand for foreign currency. The government also embarked on the freezing of prices and wages in order to bring down in which they were successful in 1987 but failed to properly implement it in 2007.
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Inflation measures undertaken by Govt. & its effect

The creation of economic processing zones (EPZ) reduced inflation as this was also complimented by an extensive program put in place in 1990 which aimed to liberalize the economy from the system of controls that have been so pervasive during the UDI and post independence decade through the economic structural adjustment program (ESAP) which sought to: i) Liberalise trade and foreign exchange which led to the formation of exchange bureaus. ii) Liberalise and promote investment, iii) Liberalise the financial sector i.e. interest rate deregulation, and the adoption of market based monetary policies and the liberalization of regulations regarding entry and exit into the industry, iv) Reform on public enterprises, rationalization of the civil service, plus the reduction by half of the budget deficit, v) The deregulation of the labour market. The government also structured the investment approval procedures, done by through the formation of the Zimbabwe Investment centre-a one stop shop window to facilitate and promote investment. It also allowed foreigners to trade on the Zimbabwe Stock Exchange (ZSE) and made it one of the most active stock exchanges in Sub Saharan Africa. We also note that the tight monetary policies during the ESAP period were vital in reducing inflation to 23% in 1995 from 42% in 1992. Furthermore, in 1998, the Zimbabwe government launched the second stage of its economic structural adjustment programme, the Zimbabwe Programme for Economic and Social Transformation (ZIMPREST). ZIMPREST outlined macro-economic reforms through to the year 2000. The plan envisaged a real annual GDP growth of 6% until year 2000 and a creation of 44,000 new jobs per year. To achieve such targets, savings and investments were expected to reach at least 23% of the GDP and the budget deficit reduced to fewer than 5%. Besides seeking to advance the unfinished work of ESAP, ZIMPREST also added socio-political goals such as improvements in the quality of democratic institutions; the pursuit of good governance; and the elimination of corruption. Thus, political conditionalitys were added to ZIMPREST. The government should also try to decrease the amount of subsidies and expenditures that they are incurring as it has
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Inflation measures undertaken by Govt. & its effect

been analysed as the main driver of inflation, it should fully liberalise the foreign exchange market through they willing buyer, willing seller approach so that both parties are able to sell and buy foreign currency from each ,so as to completely destroy the parallel market and this should be bone with complete minimization of government intervention and thus re-introduce foreign currency bureaus. The government also announces complimentary and supportive fiscal and monetary policies so as to make people believe in them that they can reduce inflation and also the issue of channeling resources to capital development projects. It should also try to institute the complete liberalization of the fuel sector, whereby we have a situation were the majority of people can be able to purchase fuel at the any service station in the country as this would curb the ever souring inflation which has been starving the precious nation the most important drive of the important drive of the industry. The need to curb/reduce new farm invasions should be done in the best interest of both parties and there should fully implement they presidential land audit, such that unproductive farmers should have they land taken and given to those who have the zeal and determination to do the task at hand. Hence we also note that the Reserve Bank introduced a tight monetary policy (contractionary) to fight inflation in 2003 as money supply was decreased 490.9% to 132.75% and in turn inflation reduced from 598.75% to 132.84% in 2004. The government should also try to ensure minimum intervention in the pricing and control of wages through they national incomes and pricing commission (NIPC), as this would enhance the availability of products on the market shelves and thus would bring down inflation as most shops had resorted to use the black market as a source of making profits as that is failing to happen through the proper channels. Through they double interest rate policy, which is meant to inflation to fight inflation through discouraging speculative and consumption borrowing through the imposing interest rates on speculative, consumption, and other non-productive activities to be
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Inflation measures undertaken by Govt. & its effect

charged unsubsidized market rates. The reduction in M3 growth through liquidity support schemes granted only to solvent and viable banks where there is no evidence of imprudent behavior, also the implementation of the overnight accommodation rates to smoothen end of day market liquidity positions.

CONCLUSION:After reading this tutorial, you should have some insight into inflation and its effects. For starters, you now know that inflation isn't intrinsically good or bad. Like so many things in life, the impact of inflation depends on your personal situation. Some points to remember:

Inflation is a sustained increase in the general level of prices for goods and services. When inflation goes up, there is a decline in the purchasing power of money. Variations on inflation include deflation, hyperinflation and stagflation.
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Inflation measures undertaken by Govt. & its effect

Two theories as to the cause of inflation are demand-pull inflation and cost-push inflation. When there is unanticipated inflation, creditors lose, people on a fixed-income lose, "menu costs" go up, uncertainty reduces spending and exporters aren't as competitive. Lack of inflation (or deflation) is not necessarily a good thing. Inflation is measured with a price index. The two main groups of price indexes that measure inflation are the Consumer Price Index and the Producer Price Indexes. Interest rates are decided in the U.S. by the Federal Reserve. Inflation plays a large role in the Fed's decisions regarding interest rates. In the long term, stocks are good protection against inflation. Inflation is a serious problem for fixed income investors. It's important to understand the difference between nominal interest rates and real interest rates. Inflation-indexed securities offer protection against inflation but offer low returns.

Webliography:

www.google.com www.yahoo.com

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Inflation measures undertaken by Govt. & its effect

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