What is Inflation?
The persistent increase in the average prices or price levels in an economy is termed Inflation. It refers to an increment in average prices of goods and services in an economy over a period of time.
It can also be understood as a situation where a higher amount of money is chasing a very less quantity of goods. It holds the power to reduce the real value of money.
- Demand-pull inflation
- Cost-push inflation (supply side)
From the monetary policy point of view, Demand-pull inflation is more important. Excess demand in the market leads to Demand-pull inflation. Aggregate demand increases with an increase in the money supply.
How To Control Demand-Pull Inflation?
The reason for this inflation is the demand which is in turn because of purchasing power. The purchasing power is dependent on the money supply. So, to tackle this inflation, the money supply has to be reduced. As the aggregate demand comes down, Demand-pull inflation can be controlled.
Reasons For Demand-Pull inflation
There are numerous reasons for Demand-pull inflation but the main cause is, if the given issue tends to increase the money supply, this inflation type might come into the picture as it eventually ends up increasing demand.
Another reason is, increase in Forex. When Forex is approaching, an equivalent amount of Rupee has to be pumped into the market, leading which again leads to an increase in money supply in the economy.
In brief, any reason that has the power to increase the money supply can be responsible for Demand-pull inflation. For example, Deficit financing, decrease indirect taxes, increase in population, increase in black money or fake currency, increase in Government or public expenditure, increase in exports and decrease in imports, etc.
A higher money supply can also lead to depreciation in Rupee at times. Demand-pull can contribute to the National Income.
Read more: Read- Budget Highlights 2021 – Income Tax Slab Rates
Reduction in supply can lead to Cost-push inflation. The supply rate depends on the cost of production. An increase in the cost of production is responsible for reduced supplies. Unlike Demand-pull, Cost-push inflation does not contribute to National Income so it is not desirable for the Indian Economy.
How to control Cost-push inflation?
A decrease in the cost of production is helpful to control this inflation type.
Reasons for Cost-push inflation
As the root cause for Demand-pull inflation was increased money supply, similarly, the root cause for Cost-push inflation is an increase in the cost of production, i.e, reduction in supply.
An increment in the price of inputs like land, labor, capital, and entrepreneurship can lead to rising in rent, a rise in wages, a rise in interest, and a rise in profit respectively which will expand the cost of production causing Cost-push inflation.
The rise in indirect taxes can also cause this type of inflation as it reduces supply. A decrease in subsidies will affect costs and increase them leading to a reduction in supply again.
Hoarding and speculation can also be a reason as they affect supplies. Depreciation of rupee can ask to pay more for imports leading to increased cost of production.
Other reasons like defective supply chain, increase in prices of imported commodities, increase in exports, etc can affect the cost of production and cause Cost-push inflation.
Summing up both types, inflation is mostly caused by the depreciation of the rupee and an increase in the price of imported commodities. For example, from 2010 to 2015, inflation was dependent on the price of crude oil.
India’s retail inflation as measured by Consumer Price Index increased to 6.3% because of an increment in food and fuel prices.
The best policy to come out of a recession is by improving the aggregate demand. The Government needs to follow an expansionary fiscal policy to pump money into the economy which will lead to higher aggregate demand.
As economists C Rangarajan and D K Srivastava suggest, in May’s last week, India came across various news updates about the nation’s GDP growth. According to the National Statistical Office’s report (NSO), India’s GDP has contracted by 7.3% in 2020-21. A growth of 7.8% will be necessary to reach the GDP levels of 2019-2020 all over again.
The second wave of the pandemic has had an adverse effect on the pandemic. The RBI has revised down its GDP growth to 9.5% for the year 2021-22. Investment Information and Credit Rating Agency (ICRA) has estimated the growth to be 9%. Indian economy is currently looking at a downward trend.
As the unlock starts again, three types of additional expenditures have to be prioritized:
- An increase in provision for income support measures for rural and urban households. For example, the funding for the Pradhan Mantri Garib Kalyan Yojna (PMGKY) should be enhanced.
- The budget for the vaccination drive was announced as 0.35 lakh crores. It should be doubled in order to have a positive impact on the Indian economy soon.
- Additional expenditure for healthcare, infrastructure should be provided.
Reduced revenue and increased expenditure would lead to a fiscal deficit of about 7.9% of GDP. In simple words, a fiscal deficit is when the government’s expenditure exceeds its revenue in a year.
Ideally, according to The Fiscal Responsibility and Budget Management Act (FRBMA), the fiscal deficit shouldn’t exceed 3% and we’re reaching 7.9%.
The Government and RBI are trying to keep the interest rate low even though there’s heavy borrowing. Its success completely relies on the support offered by the RBI and can be provided indirectly pumping in liquidity but it has its own limitations, i.e, a problem of inflation. The expansionary policy will work at the moment of crisis but the government needs to keep an eye on inflation.