PAN African e-Network Project

Diploma in Business Management

Managerial Economics & Analysis

Session - 8

Ms. Tavishi

INFLATION

Meaning of inflation
In economics, inflation is a rise in
the general level of prices of goods
and services in an economy over a
period of time. When the general
price level rises, each unit of
currency buys fewer goods and
services.

Definitions of inflation
According to Webster'sAn increase in the
amount of currency in circulation, resulting in
a relatively sharp and sudden fall in its value
and rise in prices: it may be caused by an
increase in the volume of paper money issued
or of gold mined, or a relative increase in
expenditures as when the supply of goods
fails to meet the demand.
According to Prof. Samuelson inflation occurs
when general level of prices & cost are rising.

Causes of inflation
Demand-pull inflation
Cost-push inflation
Built-in inflation

Effects of inflation

Investment
Interest rates
Exchange rates
Unemployment
Stocks
Decrease in the purchasing power
Change the allocation of income

Types of inflation
1. On the basis of the degree of
the govt control
Open inflation
Suppressed inflation

2. on the basis of political conditions

War-time inflation
Peace time inflation

3. On the basis of scope

Sectoral inflation

Comprehensive inflation

Inflation rate
India Inflation Rate
The inflation rate in India was last reported at
8.8 percent in February of 2012.

From 1969 until 2010, the average inflation

rate in India was 7.99 percent reaching an
historical high of 34.68 percent in September
of 1974 and a record low of -11.31 percent in
May of 1976.

Demand Pull
The economy usually demands more
goods and services than companies
are able to produce. This supply
shortage enables sellers to raise
prices.

Cost Push
shortages or shocks to the available
supply of a certain good or product
will cause a ripple effect through
the economy by causing a rise in
prices from the producer to the
consumer.

Money Supply
If the amount of money produced is
not controlled, it may grow at a rate
faster than that of the potential
output in the economy, or real GDP.
This can cause a drive up or rise of
prices which leads to inflation.

Wage-Price Spiral
Inflation can also be created through
an increase in wage earners
demands and then as a result the
increase in the costs of products
(goods and services). This will cause
higher prices for the wage earners or
consumers. As demands grow higher
on each side, inflation will continue
to rise.

Depreciation
As a result of inflation, the value of
many goods and services will
change, as the goods and services
become more expensive.

Distribution of Income
As a result the of the inflation, the
gaps between income will seem a lot
more vast as the increases in price
will affect the various classes
differently.

Shifts in Spending Habits

As wages change to adjust to the
inflation rates, people start to change
how they spend their money and
what they spend it on.

Speculation Spending
When people think that there will be
an increase in price on a particular
good, they usually try to beat the
price increase by buying the good in
large amounts before the price
increase happens.

Controlling inflation
There are broadly two ways of controlling inflation in an
economy:

1). Monetary measures

2). 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.

Monetary measures used to

control inflation include:
(i) bank rate policy
(ii) CRR
(iii) open market operations

II). Fiscal Measures

Fiscal measures to control inflation
include taxation, government
expenditure and public borrowings.

Fiscal measures used to

control inflation include:
(i)Increase in Taxes
(ii) Increase in savings
(iii) surplus budgets

Reserve Bank of
India
The central bank of the country--Reserve Bank of India (RBI).
Established in April 1935 with a share capital of Rs. 5 crores on
the basis of the recommendations of the Hilton Young
Commission.
The share capital was divided into shares of Rs. 100 each fully
paid up which was entirely owned by private shareholders in the
beginning.
The Government held shares of nominal value of Rs. 2,20,000.
Reserve Bank of India was nationalized in the year 1949
No of members on central board is 20 (incl. governor and 4
deputy governors)

Need for the Reserve

Bank

The Reserve Bank of India Act, 1934 was

commenced on April 1, 1935.
The Act, 1934 (II of 1934) provides the
statutory basis of the functioning of the
Bank.

The Bank was constituted for the need of

following:
To regulate the issue of banknotes
To maintain reserves with a view to
securing monetary stability and
To operate the credit and currency system

Functions of Reserve Bank of Ind

The Reserve Bank of India Act of 1934 contains
all the important functions of a central bank to the
Reserve
Bank
of Bank
Issueof India.
Under Section 22 of the Reserve Bank of India Act,
the Bank has the sole right to issue bank notes of all
Banker to Government
denominations.
The second important function of the reserve bank of India is to
act as government banker, agent and adviser. RBI carries out
banking operations (e.g. to receive and make payments, carry
cash reserves) for all governments except J&Kacts as advisor
to govt on all monetary and banking matters.

Bankers' Bank and Lender of the Last Resort

The scheduled banks can borrow from the Reserve

Bank of India on the basis of eligible securities or get
financial accommodation in times of need or
stringency. Banks have been asked to keep cash

Functions of Reserve
Bank of India

Controller of Credit
The Reserve Bank of India is the controller
of credit i.e. it has the power to influence
the volume of credit created by banks in
India. It can do so through changing the
Bank rate or through open market
operations.

Controller of money market

The Reserve Bank of India is armed with
many more powers to control the Indian
money market

Custodian of foreign exchange

reserves

A) TRADITIONAL
FUNCTIONS
1. Monopoly of currency notes issue
2. Banker to the Government(both the central and
state)
3. Agent and advisor to the Government
4. Bankers Bank
5. Acts as the clearing house of the country
6. Lender of the last resort (B R P)
7. Custodian of the foreign exchange reserves
8. Maintaining the external value of domestic
currency
9. Controller of forex and credit (Credit Policy)
10. Ensures the internal value of the currency
11. Publishes the Economic statistical data
12. Fight against economic crisis and ensures stability

B) PROMOTIONAL FUNCTIONS
1. Promotion of banking habit and expansion of
banking systems.
2. Provides refinance for export promotion. (E P C G)
3. Expansion of the facilities for the provision of the
agricultural
credit through NABARD.
4. Extension of the facilities for the small scale
industries.
5. Helping the Co-operative sectors.
6. Prescribe the minimum statutory requirement.

C) SUPERVISORY FUNCTIONS

1. Granting license to Banks.

2. Inspecting and making enquiry or determining
position in
respect of matters under various sections of RBI
and Banking
regulations.
3. Periodical review of the work of the commercial
banks.
4. Giving directives to commercial banks.
5. Control the non-banking finance corporations.
6. Ensuring the health of financial system through
on-site and

Non Monetary Functions

Role as Supervisor

RBI enjoys wide powers of supervision and control

over commercial and co-operative banks, relating to
licensing and establishments,
branch expansion,
liquidity of their assets,
management and methods of working,
amalgamation,
reconstruction,
and liquidation.
The RBI is authorized to carry out periodical
inspections of the banks and to call for returns and
necessary information from them..

Non Monetary Functions

Promotional functions

The major function of Reserve Bank is to promote banking

habit, extend banking facilities to rural and semi-urban areas,
and establish and promote new specialized financing agencies.
Accordingly, the Reserve Bank has helped in the setting up of
the
IFCI
SFC
Deposit Insurance Corporation in 1962
Unit Trust of India in 1964,
Industrial Development Bank of India in 1964

Monetary Policy
What is monetary policy?
A macroeconomic policy tool used to
influence interest rates, inflation, and
credit availability through changes in
the supply of money available in the
economy. In India it is also called the
Reserve Bank of Indias Credit Policy
as the stress is primarily on directing
credit.

Monetary Policy of
RBI
CONTROLLED EXPANSION(1951-72)
Speed up economic development in the country to raise
national income and standard of living.
To prevent heavy depreciation of the rupee.
Maintaining the momentum of economic growth. To consider
measures in a calibrated manner to respond to evolving
circumstances with a view to stabilizing inflationary
expectations.
RBIs ANTI-INFLATIONARY POLICY SINCE 1972
Economic aims given above were nearly the same but policy of
CONTROLLED EXPANSION was changed to CREDIT RESTRAINT.

TOOLS OF MONETARY
POLICY
There are two kinds of tools:

Quantitative tools control the volume of

credit and inflation, indirectly.

Qualitative tools they control the supply

of money in selective sectors of the economy.

Quantitative Tools
Bank Rate
Bank Rate is the rate at which RBI allows finance to commercial banks.
Bank Rate is a tool, which RBI uses for short-term purposes. Any revision
in Bank Rate by RBI is a signal to banks to revise deposit rates as well as
Prime Lending Rate.
Role of bank rate is limited in India because
The structure of interest rates is administered by RBI
Commercial banks enjoy specific refinance facilities.

CRR
All scheduled commercial banks are required to maintain a fortnightly
minimum average daily cash reserve equivalent with RBI .The apex bank
is empowered to vary this ratio between 3 and 15 per cent. RBI uses CRR
either to impound the excess liquidity or to release funds needed for the
economy from time to time.

 SLR
Every bank is required to maintain at the close of business every day, a
minimum proportion of their Net Demand and Time Liabilities as liquid
assets in the form of cash, gold etc, in addition to cash reserve
requirements. The ratio of liquid assets to demand and time liabilities is
known as Statutory Liquidity Ratio (SLR). Present SLR is 24%.
Repos and Reverse Repo
RBI is empowered to enter a transaction in which two parties agree to sell and
repurchase the same security. Under such an agreement the seller sells specified
securities with an agreement to repurchase the same at a mutually decided future
date and a price. Similarly, the buyer purchases the securities with an agreement to
resell the same to the seller on an agreed date in future at a predetermined price.
Such a transaction is called a Repo when viewed from the prospective of the seller of
securities (the party acquiring fund) and Reverse Repo when described from the
point of view of the supplier of funds. Thus, whether a given agreement is termed as
Repo or a Reverse Repo depends on which party initiated the transaction.

OPEN MARKET OPERATIONS

An instrument of monetary policy
It involves buying and selling of govt. securities by the
RBI to influence the volume of cash reserves with
commercial banks and thus influence their loans and
advances
To contract the flow of credit ,RBI starts selling govt
securities
To increase the credit flow RBI starts purchasing the
govt securities.

Selective and Direct Credit

Control Or Qualitative
Measures

The main objective is to check speculation and

rising prices
The RBI issues directives to banks relating to
the purpose for which advances may or may not be
made
The margins to be maintained in respect of secured
advances
The maximum amount of advance to any borrower
The maximum amt. of guarantee that can be given
on behalf of any firm

Kinds of Selective Credit

Controls
Specifies minimum margins for lending
against specific securities
Ceiling on amt of credit for certain
purposes to stem the flow of credit to
speculative and non productive sectors
Charges discriminatory rate of interest
on certain types of advances

Monetary Policy 200506

Key Figures
Reverse Repo Rate Hiked by 25 bps, stands at
5%
Repo Rate Unchanged at 6%
Bank Rate Unchanged at 6%
CRR Unchanged at 5%
Inflation FY06 5-5.5%
GDP FY06 Target 7%

Current Monetary
Policy
Key Figures

Reverse Repo 4%
Repo Rate 4.25%
Bank Rate 6%
CRR Unchanged 5.5%
Inflation 5.07%

Monetary Policy of India is formulated and executed by

reserve bank of India to achieve specific objectives.
The monetary policy is defined as discretionary act
undertaken by the authorities designed to influence (A)
the supply of money (B) cost of money or rate of interest
(C) the availability of money for achieving specific
objectives
The main elements of monitory policy are
(1)It regulates stock and growth rate of money supply
(2)It regulates the entire banking system of the economy
(3)It regulates the level an structure of interest rates
directly in organised sector and indirectly in
unorganised sector
(4)It determines the allocation of loans among different
sectors

CD Deshmukh
The First Indian Governor
of
Reserve Bank of India
(RBI)

Dr. D. Subbarao
Present Governor of RBI

 Bank Rate is also known as discount rate. It is

the rate at which RBI lends to the commercial
banks or rediscounts their bills. If bank rate is
increased ,then commercial banks also charge
higher rate of interest on loans given by banks
to public because now commercial banks get
funds from RBI at higher rate of interest.
Higher rate of interest will contract credit in
the economy i.e. public will take lesser loans
because of higher rate of interest. The
current bank rate is 10.25%

DATE

Bank
Rate

DATE

Bank
Rate

DATE

Bank
Rate

15 - July
2013

10.25

2-Mar1999

8.00

9-Jan1971

6.00

03 - May
2013

8.25

29-Apr1998

9.00

2-Mar1968

5.00

19 - March 8.50
2013

3-Apr1998

10.00 17-Feb1965

29January
-2013

8.75

19-Mar- 10.50 26-Sep- 5.00

1998
1964

17-April2012

9.00

17-Jan1998

11.00 3-Jan1963

13-Feb2012

9.50

22-Oct1997

9.00

29-Apr2003

6.00

26-Jun1997

10.00 15-Nov- 3.50

1951

30-Oct-

6.25

16-Apr-

11.00 28-Nov- 3.00

6.00

4.50

16-May- 4.00
1957

 It means a certain percentage of deposits is

to be kept by banks in form of liquid assets.
This is kept by bank itself the liquid assets
here include government securities, treasury
bills and other securities notified by RBI. If
SLR is more then banks have to keep more
part of deposits in specified securities and
banks will have less surplus funds for
granting loans. It will contract credit.SLR is
fixed by RBI and usually it has been ranging
between 24% to 39%.The current SLR is 23%.

 It means that the bank controls the flow of

credit through the sale and purchase of
securities in the open market. When securities
are purchased by central bank, then RBI makes
payment to commercial banks and public. So,
the public and commercial banks now have
more money with them. It increases money
supply with commercial banks and public. This
will expand credit in the economy. In year 201213 RBI Purchases securities 8,000 crore

 Cash Reserve Ratio is a certain percentage

of bank deposits which banks are required to
keep with RBI in the form of reserves or
balances .Higher the CRR with the RBI lower
will be the liquidity in the system and viceversa.RBI is empowered to vary CRR
between 15 percent and 3 percent. But as
per the suggestion by the Narshimam
committee Report the CRR was reduced from
15% in the 1990 to 5 percent in 2002. As of
January 2013, the CRR is 4.00 percent

 Repo rate is the rate at which RBI lends to commercial

banks generally against government securities. Reduction
in Repo rate helps the commercial banks to get money at
a cheaper rate and increase in Repo rate discourages the
commercial banks to get money as the rate increases and
becomes expensive. Reverse Repo rate is the rate at
which RBI borrows money from the commercial banks.
The increase in the Repo rate will increase the cost of
borrowing and lending of the banks which will discourage
the public to borrow money and will encourage them to
deposit. As the rates are high the availability of credit and
demand decreases resulting to decrease in inflation. This
increase in Repo Rate and Reverse Repo Rate is a symbol
of tightening of the policy. As of August 2013, the repo
rate is 7.25% and reverse repo rate is 6.25

 Margin is the difference between loan value and

market value of security. It is fixed by RBI. For
different types of loans, margin requirement is
different .If margin % is more, then less loan will
be given for a certain value of security and vice
versa. E.g. if margin requirement is 20% then
bank will give maximum 80% of the market value
of security as loan. For priority sector, margin
requirement is less and in areas where credit is
to be contracted margin requirement is
increased.

Reserve bank can also exercise moral

influence upon the members banks
with a view to pursue its monetary
policy. RBI convinces banks to curb
loan to unproductive sectors. From
time to time reserve bank holds
meetings with the member banks
seeking their cooperation in
effectively controlling the monetary
system of the country. It advices

 According to 1949 act, Reserve bank

can stop any commercial bank from
any type of transaction. In case of
defiance of the orders of reserve
bank, it can resort to direct action
against the member bank. It can stop
giving loans and even recommend
the closure of the member bank to
the central government under
pressing circumstances.

 In this operation RBI issues prior

information or direction that loans to
the commercial banks will be given
up to a certain limit. In this case
commercial bank will be tight in
advancing loans to the public. They
will allocate loans to limited sectors.
Few example of ceiling are
agriculture sector advances, priority
sector lending.

RBI's first-quarter monetary policy

Repo rate unchanged at 7.25%.
The Reverse Repo Rate stood at 6.25%
Marginal Standing Facility (MSF) and Bank Rate stood at
10.25%
Cash reserve ratio too unchanged at 4 percent
Cuts GDP forecast for FY'14 to 5.5 percent from 5.7
percent earlier
Next mid-quarter review of policy on September 18;
second quarter policy review on October 29.
This is RBI Governor D Subbarao's last policy before
expiry of his five year term.

 Fiscal policy is related to income and

expenditure of the government. It is
an instrument for promoting
economic growth, employment,
social welfare etc. Fiscal policy
means any decision to change the
level, composition or timing of
government or to change the rate
and structure of tax. The objectives
of fiscal policy is same as of

Public expenditure influences the economic activities

of country very much. Public expenditure may be
of two kinds i.e. developmental and non
developmental. Expenditure on developmental
activities requires huge amount of capital. So much
capital cannot be made available by private sector
alone. It requires substantial increase in public
expenditure. Public expenditure may be made in
many ways (1) Development of state enterprises
(2) support to private sector (3) Develpoment of
infrastructure (4) Social Welfare.

 Taxes are the main source of revenue of government.

Government levies both direct and indirect taxes in
India. Direct taxes are those which are directly paid by
the assesses to the government i.e. income tax, wealth
tax etc. Indirect tax are paid indirectly by the public to
the government i.e. excise duty, custom duty, VAT etc.
Direct tax are progressive in nature. Indirect tax are not
progressive. These change from all the segments of
society at same rate. The main objectives of taxation
policy are:
(1)Mobilisation of resources
(2)To promote saving
(3)To promote saving
(4)To bring Equality of income and wealth

 Government needs lot of funds for economic development of the

country. No government can mobilise so much funds by way of tax
alone. It is therefore , becomes inevitable for the government to
mobilise resources for economic development by resorting the
public debt. Public debt is obtained from two kinds
(1) Internal Debt
(2) External Debt
Public Debt Of current year (In crores of Rupees)
As on 31st March 2013
As on 31st March 2014
Internal debt 48,66,829.00
54,68,622.11
External debt 1,72,302.01
1,82,862.11
Total
50,39,131.01
56,51,484.22

Deficit Financing refers to financing the budgetary

deficit. Budgetary deficit here means excess of
government expenditure over government income.
It means Taking loans from reserve bank of India by
the government to meet the budgetary deficit .
Reserve bank gives loans buy issuing new currency
notes. Increase in money supply leads to fall in
value of money. Fall in value of money in turn leads
to increase in price level. So deficit financing should
be kept low as it leads to price rise in economy.
Thus due to deficit financing necessary funds are
made available for economic Growth and on the
other inflation of country increases.

Total Expenditure 16,65,297

Revenue Expenditure 14,36,168
Capital Expenditure 2,29,129
Plan Expenditure at ` 5,55,322 crore.
Fiscal deficit for the current year contained at 5.2 per cent and
for the year 2013-14 at 4.8 per cent.
Revenue deficit for the current year at 3.9 per cent and for
the year 2013-14 at 3.3 per cent.
By 2016-17 fiscal deficit to be brought down to 3 per cent,
revenue deficit to 1.5 per cent and effective revenue deficit to
zero %
No change in the normal rates of 12 percent for excise duty
and service tax.
No case to revise either the slabs or the rates of Personal
Income Tax. Even a moderate increase in the threshold
exemption will put hundreds of thousands of Tax Payers
outside Tax Net

Stagflation
A condition of slow economic growth
and relatively high unemployment - a
time of stagnation - accompanied by
a rise in prices, or inflation.

Stagflation

Stagflation occurs when the economy

isn't growing but prices are, which is
not a good situation for a country to
be in. This happened to a great
extent during the 1970s, when world
oil prices rose dramatically, fueling
sharp inflation in developed
countries. For these countries,
including the U.S., stagnation
increased the inflationary effects.

Hyperinflation

Extremely rapid or out of control

inflation. There is no precise
numerical definition to hyperinflation.
Hyperinflation is a situation where
the price increases are so out of
control that the concept of inflation is
meaningless.

Hyperinflation
When associated with depressions,
hyperinflation often occurs when
there is a large increase in the
money supply not supported by gross
domestic product (GDP) growth,
resulting in an imbalance in the
supply and demand for the money.
Left unchecked this causes prices to
increase, as the currency loses its
value.

Hyperinflation
One of the most famous examples of
hyperinflation occurred in Germany
between January 1922 and
November 1923. By some estimates,
the average price level increased by
a factor of 20 billion, doubling every
28 hours.

Germany
The harsh reparation payments
imposed on Germany led the mark to
depreciate against foreign
currencies. Also, the new democratic
socialist leaders had promised the
people all types of bounties-increased wages, reduced hours, an
expanded educational system, and
new social benefits. But all this
meant a vastly increased demand on

 By February 1920 this inflationary episode had run

its course. For the next fifteen months the price
index held stable. The mark actually gained in
value against foreign currencies, so that prices of
imported goods fell by some 50%. Here was a
golden opportunity to establish a stable currency.
However, during these fifteen months the
government kept issuing new money. The currency
in circulation increased by 50% and the floating
debt of the Reichsbank by 100%, providing fuel for
a new outbreak.

 In May 1921, price inflation started

again and by July 1922 prices had
risen
700%.
The
Reichsbank
continued printing new currency,
although more slowly than the rate
at which prices were rising. In fact,
all through this period the issue of
currency proceeded at a fairly
smooth steady rate, while the price
index moved up in great surges,

 After July 1922 the phase of

hyperinflation began. All confidence
in money vanished and the price
index rose faster and faster for
fifteen
months,
outpacing
the
printing presses which could not run
out money as fast as it was
depreciating.

 From Mid-1922 to November 1923 hyperinflation

raged. The table above tells the story. Seemingly
Reichsbank officials believed that the basic trouble
was the depreciation of the mark in terms of
foreign currencies. In late 1922 they tried to
support the mark by purchasing it in the foreign
exchange markets. However, since they continued
printing new currency at a feverish rate, the
attempt failed. They merely succeeded in buying
worthless marks in return for valuable gold and
foreign exchange.

 All hope of checking the collapse of the mark

vanished in January 1923 when the French-alleging treaty violations--occupied Germany's key
industrial district, the Ruhr. Germany subsidized
the occupied companies and financed an
expensive program of "passive resistance." New
billions of marks were printing to finance these
heavy new costs. By late 1923, 300 paper mills
were working top speed and 150 printing
companies had 2000 presses going day and night
turning out currency.

 Under the forced draft of inflation, business was now

operating at feverish speed and unemployment had
disappeared. However, the real wages of workers
dropped badly. Unions obtained frequent increases, but
these could not keep pace. Workers --domestics, farm
workers and various white collar groups-- fared
especially badly. They had no unions to fight for pay
boosts for them, and often they were reduced to
hunger. Many people showed visible signs of
malnutrition. Skilled workers, writers, artisans and
professionals found their wages lagging until they
reached the unskilled worker level, which often meant
the bare minimum needed to support life.

 Businessmen began to abandon their

legitimate occupations to speculate
in stocks and in goods. Thousands of
small businessmen tried to eke out a
living by speculating in fabrics,
shoes, meat, soap, clothing--in any
produce they could obtain. Each fall
in the mark brought a rush to the
shops. People bought dozens of hats
or sweaters.

 By mid-1923 workers were being paid as often as

three times a day. Their wives would meet them, take
the money and rush to the shops to exchange it for
goods. However, by this time, more and more often,
shops were empty. Storekeepers could not obtain
goods or could not do business fast enough to protect
their cash receipts. Farmers refused to bring produce
into the city in return for worthless paper. Food riots
broke out. Parties of workers marched into the
countryside to dig up vegetables and to loot the farms.
Businesses started to close down and unemployment
suddenly soared. The economy was collapsing.

 Meanwhile, middle-class people who

depended on any sort of fixed
income found themselves destitute.
They sold furniture, clothing, jewelry
and works of art to buy food. Little
shops became crowded with such
merchandise. Hospitals, literary and
art societies, charitable and religious
institutions closed down as their
funds disappeared.

 Throughout the "miracle of the

Rentenmark" the depreciation halted
in its tracks, business revived, the
inflationary spree was ended
although, as we shall see, there was
a nasty hangover yet to come.

 Millions of middle-class Germans--normally the mainstay

of a republic--were ruined by the inflation. They became
receptive to rabid right wing propaganda and formed a
fertile soil for Hitler. Workers who had suffered through
the inflation turned, in many cases, to the Communists.
The biggest beneficiaries of this enormous redistribution
of wealth were feudalistic industrial leaders who
distrusted the democracy and who proved willing to deal
with Hitler, thinking that they could control him. The
democratic parties and the labor unions lost their capital
and were weakened. The liberal democratic regime was
discredited.

Thank You
Please forward your query
To: tavishie@amity.edu