project report on inflation new

7/29/2019 Project Report on Inflation New

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Project on inflation on its impact on india companies and economy

Submitted by:A r j u n

I I P M

IIPM,SAKET,NEAR KVPV


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C

CONTENT

1.WHAT IS INFLATION?

2.INFLATION IN VARIOUS SECTOR OF INDIA

3.ITS IMPACT ON SAVING AND INVESTMENT?

4.ITS IMPACT ON AUTOMOBILE INDUSTRIES IN INDIA ?

5.ITS IMPACT ON INDIAN ECONOMY?

6.IMPACT ON COMPANY INVESTMENT?


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7.HOW IT IS MEASURED?

8.CAUSES OF INFLATION

10.METHOD OF CONTROL

11. MONETARY PHENEMONEN

INFLATION

Inflation can be defined as a rise in the generalprice level and therefore a fall in the value of


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money. Inflation occurs when theamount ofbuying power is higher than the output of goodsand services. Inflation also occurs when the amountof money exceedsthe amount of goods and servicesavailable. As to whether the fallin the value ofmoney will affect the functions of money

dependson the degree of the fall. Basically,refers to an increase in thesupply of currency orcredit relative to the availability of goodsandservices, resulting in higher prices. Therefore,

inflation can be measured in terms of percentages.

The percentage increase in the price index, as a


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rate per cent per unit of time, which is usually in

years. The two basic price indexes areused when

measuring inflation, the producer price index

(PPI) and the consumer price index (CPI) which is

also known as the cost of living index number.

Effect of Inflation on Car Market

Inflation always has a negative effect on the car market. The

development of the car market comes to a standstill whenthere is inflation in the market. The effect of inflation on car


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market is not at all encouraging and it badly affects everysector, which is associated with vehicle production andmanufacturing. The hike in the rate of steel and fuel hasresulted in a slower rate of development of the Indianautomotive industry. One of the major effects of inflation isthat the manufacturing of Indian cars has been hindered to asignificant extent.

It has also been witnessed that major Indian vehiclemanufacturers such as Tata Motors, Mahindra and Mahindra,Hyundai, Maruti Suzuki, and Honda Siel Motors areattempting their best to improve their manufacturing and

sales of the vehicles amidst the situation where the stockmarket is showing a sluggish growth. It has also been seenbecause of inflation that sales of particular vehicles are being


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stimulated by the discounted rates that the car manufacturersare providing to the customers. Some of the vehicle makershave even resorted to offering exchange offers to thecustomers and some have launched competitive carfinancing rates. The effect of inflation has resulted in the hikeof vehicle prices to the extent of 3%-4%, which sequentially isadequate for the necessity of meeting the hike of rates of rawmaterials for making an automobile.

The effect of inflation on car market has not only badlyimpacted the manufacturing and sales of Indian vehicles butalso the vehicle dealers, employees, and vehicle financers.

Surveys and studies have resulted in the conclusion that thevehicle market and the vehicle manufacturing industry in


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India experienced 8-9% slump due to inflation.

The effect of inflation on vehicle manufacturers haveconsequently affected the vehicle dealers in a manner wherethey are being forced to thrust the sales curve upward andmaintain a high volume of profit. In this arrangement, thevehicle financers are compelled by both vehicle dealers and

vehicle manufacturers to offer the customers a 100%financial assistance by lowering the interest rate of the loan.

On the whole, it has been observed that the car market inIndia (both passenger car market and commercial vehicles

market) has witnessed a slump with the inflation badly hitting


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nearly every sector to which the Indian automobile market isclosely associated.

India and China car sales hit by inflation

By Mary Watkins in Mumbai and Patti Waldmeir in Shanghai

New car sales figures from India and China have highlighted

the damaging impact of high fuel prices, inflationarypressures and supply bottlenecks on consumer spending inthe worlds two largest emerging economies.

The Society of Indian Automobile Manufacturers (SIAM) saidthat sales of cars in India in May rose 7 per cent to 158,817compared with 148,425 the year before the slowest rate ofgrowth in two years.


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The deceleration shows how a combination of rising interestrates on car and home loans, as well as the higher cost of fueland other essential items, is encouraging some Indianconsumers to postpone discretionary purchases.

India has raised interest rates nine times in just over a year asit tries to curb inflation. Petrol prices, meanwhile, rose nearly9 per cent last month.

In China, data released on Thursday showed that May carsales slipped 0.1 per cent year on year, confirming thesubstantial slowdownevident in the worlds largest automarket since small-car tax incentives were removed at theend of last year. Sales in the first five months rose 6.1 per cent

year on year, compared with last years full-year growth rateof 32 per cent.
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Given the headwinds present in recent months includingrising fuel prices, limits on [vehicle] registrations inmegacities, Japan earthquake supply shortages and theelimination of incentives, this is a actually a solidperformance and indicates that the market is fundamentallystrong, says Bill Russo, head of Synergistics autoconsultancy and former head of Chrysler in China.

Ivo Naumann, China head of AlixPartners, forecast

recently that China light vehicle sales would grow 10 to 15 percent this year despite the current slowdown, as moreconsumers become wealthy enough to own cars.

SIAM said that, based on the current performance, hitting

full-year targets would be difficult. The Indian industry bodyis forecasting that overall vehicle sales could grow at just 15


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per cent in the year to March 2012, compared with 30 percent last year.

Jatin Chawla, an automotive analyst at IIFL in Mumbai, said

he expected to see a slowdown in car sales in India in thenext three to four months, adding that a strong pickup in thefestive period from September onwards would be critical forcarmakers.

Mr Chawla said that Maruti Suzuki could expect to maintainmarket share as consumers stuck with more conservativecarmakers that produced tried and tested models. Maruti which is currently trying to resolve a strike with workers at itsManesar plant in India who are trying to secure recognition

for a new union recently reported a slowdown in car sales.Effect of inflation on india investment COMPANY
http://markets.ft.com/tearsheets/performance.asp?s=in:MARUTIhttp://markets.ft.com/tearsheets/performance.asp?s=in:MARUTI


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For world economic markets, inflation is a fairly new experience

as for much of the pre-twentieth century there had been little

upward pressure on prices due to gold and other metallic

standards. These backed currencies limited governments

abilities to create new money. So at the end of the gold standard

strong political pressures often caused governments to issue

more money increasing the money supply and therefor the price

level.

Inflation reflects a situation where the demand for goods and

services exceeds their supply in the economy(Hall, 1982). Its

causes could be triggered by the private sector and the

government spending more than their revenues, or by shortfalls

in output. Price increases could also be triggered by increases in


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costs of production. For instance increases in prices of imported

raw materials will cause inflation if not managed. Whatever the

initial cause, inflation will not persist unless accompanied by

sustained increase in money supply. In this sense, inflation is amonetary phenomenon.

But what effect does inflation have on the economy and on

investment in particular? Inflation causes many distortions in the

economy. It hurts people who are retired and living on a fixed

income. When prices rise these consumers cannot buy as much

as they could previously. This discourages savings due to the fact

that the money is worth more presently than in the future. Thisexpectation reduces economic growth because the economy


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needs a certain level of savings to finance investments which

boosts economic growth. Also, inflation makes it harder for

businesses to plan for the future. It is very difficult to decide how

much to produce, because businesses cannot predict the demandfor their product at the higher prices they will have to charge in

order to cover their costs. High inflation not only disrupts the

operation of a nation's financial institutions and markets, it also

discourages their integration with the rest of the worlds markets.

Inflation causes uncertainty about future prices, interest rates,

and exchange rates, and this in turn increases the risks among

potential trade partners, discouraging trade. As far as

commercial banking is concerned, it erodes the value of the

depositor's savings as well as that of the bank's loans. The


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uncertainty associated with inflation increases the risk associated

with the investment and production activity of firms and

markets.

The impact inflation has on a portfolio depends on the type of

securities held there. Investing only in stocks one may not have

to worry about inflation. In the long run, a companys revenue

and earnings should increase at the same pace as inflation. But

inflation can discourage investors by reducing their confidence in

investments that take a long time to mature. The main problem

with stocks and inflation is that a company's returns can be

overstated. When there is high inflation, a company may looklike it's doing a great job, when really inflation is the reason


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behind the growth. In addition to this, when analyzing the

earnings of a firm, inflation can be problematic depending on

what technique the company is uses to value its inventory.

The effect of inflation on investment occurs directly and

indirectly. Inflation increases transactions and information costs,

which directly inhibits economic development. For example,

when inflation makes nominal values uncertain, investment

planning becomes difficult. Individuals may be reluctant to enter

into contracts when inflation cannot be predicted making

relative prices uncertain. This reluctance to enter into contracts

over time will inhibit investment which will affect economicgrowth. In this case inflation will inhibit investment and could


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result in financial recession(Hellerstein, 1997). In an inflationary

environment intermediaries will be less eager to provide long-

term financing for capital formation and growth. Both lenders

and borrowers will also be less willing to enter long-termcontracts. High inflation is often associated with financial

repression as governments take actions to protect certain sectors

of the economy. For example, interest rate ceilings are common

in high inflation environments. Such controls lead to inefficient

allocations of capital that inhibit economic growth

The hardest hit from inflation falls on the fixed-income investors.

For example, suppose one year ago an investor buys a $1,000 T-bill that yields 10%. When they collect the $1,100 owed to them,


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is their $100 (10%) return real? No, assuming inflation was

positive for the year, the purchasing power of the investor has

fallen and thus so has the real return. The amount inflation has

taken out of the return has to be taken into account. If inflationwas 4%, then the return is really 6%. By the Fisher equation

(nominal interest rate inflation rate = real interest rate) we see

the difference between the nominal interest rate and the real

interest rate. The nominal interest rate is the growth rate of the

investors money, while the real interest rate is the growth of

their purchasing power. In other words, the real rate of interest

is the nominal rate reduced by the rate of inflation. Here the

nominal rate is 10% and the real rate is 6% (10% - 4% = 6%).


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Inflation causes anxiety particularly for retirees who are

uneasy about inflation adjustments to their pensions and

financial investments. Planning for retirement requires

expectations of future prices. Inflation makes this more difficultbecause even a series of small, unanticipated increases in the

general price level can significantly erode the real value of

savings over time. Social Security payments are now indexed to

inflation, a policy change that has reduced the effects of inflation

uncertainty on retirement.

There are securities that offer investors the guarantee that

returns are not eaten up by inflation. Treasury Inflation-


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Protected Securities are a special type of Treasury note or bond

that offers protection from inflation.

With a regular Treasury bond, interest payments are fixed,

and only the principal fluctuates with the movement of interest

rates. The yield on a regular bond incorporates investors'

expectations for inflation. So at times of low inflation, yields are

generally low, and they generally rise when inflation does.

Treasury Inflation-Protected Securities are like any other

Treasury bills, except that the principal and coupon payments are

tied to the consumer price index (CPI) and increased to

compensate for any inflation. As with other Treasury notes,when you buy an inflation-protected or inflation-indexed


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security, you receive interest payments every six months and a

principal payment when the security matures. The difference is

that the coupon payments and underlying principal are

automatically increased to compensate for inflation by trackingthe consumer price index (CPI). Treasury Inflation-Protected

Securities are the safest bonds in which to invest. This is because

the real rate of return, which represents the growth of

purchasing power, is guaranteed. The downside is that because

of this safety and the lower risk, inflation-protected bonds offer a

lower return.

Sustained inflation is damaging to long-run growth and thefinancial system in general. Increases in inflation lead to lower


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real returns not just on money, but on all other assets too. These

low returns interfere with the functioning of financial markets

and the allocation of investment. Lower real returns have the

effect of severely damaging the credit market. As a result, higherinflation contracts the supply of credit available to fund capital

investment damaging the economy(Blume, 1978).

It has been shown that inflation affects investment in several

ways, mostly inhibiting economic growth. The source of inflation

is money and the supply of it. Investors need to be able to expect

returns in order for them to make financial decisions. If people

cannot trust money then they are less likely to engage inbusiness relationships. This results in lower investment,


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production and less socially positive interactions. Among other

effects, people may start to attempt to trade by other, less

efficient, means in order to avoid the unpredictable price levels

due to inflation.

Effect of inflation on our saving and investment

Inflation affects your earnings, your investments, what you canpurchase and your lifestyle. It may seem like a technical conceptbest left to economists to discuss, but heres why you need to know

more about it.

In March 2010 various agencies are expected to assess inflation forthe fiscal year of 2009-2010 at anywhere from around 6.5% (RBI


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estimate as of October 09 policy review) to 8% (as per Citi

economist Rohini Malkani, noted Dec 14, 2009 in the EconomicTimes).

That means, since the previous tax year, on average goods andservices in India will cost from 6.5% to 8% more than the previousyear.

With luck, you may have had a salary increase of that amount to

keep up with your lifestyle expenses. With the economic downturn,you may not have had the increase.

What about your investments? If you held a diversified portfoliowith debt and equity and earned around 15%, you are doing well.You earned money in real terms. Anything more than that is icingon the cake (provided the investment continues to do well, that is,or you sell it). If you held all your money in FDs yielding 6% to 7%


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or in a cash account at the bank earning 3% to 4%, then youactually lost money this year. You will be able to purchase less forthe same price than you could last year.

This concept is hard to accept: you want your money to be safe andstable but in going the totally safe route, you may be losing moneylong term. Many Debt products can be safe options and return a bitmore than inflation. A Provident fund investment (obligatory formany in large companies) earns currently around 8%.

We are not discounting debt and other safe options for yourmoneyit is an important part of every portfolio, giving stabilitythrough assured returns, safety through the fact that it is a non-correlated asset (meaning debt wont decrease in value when shares

do, usually it will increase in value) and an assurance that it will bethere no matter what. If all the companies that we invest in through


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mutual funds and/or directly, went bankrupt (obviously not likely),in theory, the Provident Fund and other debt options would still bethere to see you through.

Really the best option, however is to be sure you have enoughdiversity in your portfolio to allow for growth, best capturedthrough equity. Equity tends to grow faster than debt and usuallyoutpaces inflation.

Inflation is more important for emerging markets like India thandeveloped markets. The currency, economy, prices and generaleconomic system are more volatile and growing faster and willgenerally produce sharp swings in inflation that must be closelymonitored. If you watch carefully, invest well and are well advised,

you can do well. In a highly inflationary environment, investmentswill often also earn higher returns to reward investors.


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Inflation is often matched by fast growth rates which produce goodearnings for companies that people and mutual funds invest in. Butit musnt get out of control. This is why the government closely

monitors inflation to make sure it wont get too high. If it does,

watch for fiscal and monetary policies like taxing inflows offoreign dollars, raising interest rates and removing any stimulusmeasures put in place during the economic slowdown. One impactof the very slow to negative growth we are currently seeing in

many of the Western countries is near zero inflation. It correspondsto growth.

This is why inflation is not static. Inflation for assessment year2007-2008 was 4.5%. It changes all the time and we are not able to

predict it with great accuracy. This is why it helps to keep an eye onit.


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Another factor to be aware of is how uneven inflation can be.Education costs in both the USA and in India have far outpacedaverage inflation for many years. At InvestmentYogi in ourfinancial plans, we currently use an inflation figure of 6% (this

represents a historical average with future predicted inflationfactored in) and an education inflation figure of 10%. This isimportant when planning your childs higher education, whetherinIndia or abroad. Food prices worldwide also fall in the higher

inflation rates (for November alone increase was 19% as perEconomic Times of Dec 14), and are expected to for years to come,while other consumer goods may not have changed prices or mayhave gone down.

Retirement is a key area to watch out for. You must save largeamounts and save early in order for earnings and compoundedgrowth to increase sufficiently to support you in your old age.


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Think about 7% (if inflation stays there!) per year for the next 40years. Just make sure that money is diversified in your investments!And for current retirees, they need to have access to Safe money

but woe to those who dont hold some equity and are looking at the

next 20 years in retirement. That is a long time to make your moneylast in a world of rising prices. The era of company-offeredpensions is declining and one must look out for oneself. Even thosewith a pension will fast find its value eroding if the pension amount

is fixed and the economy is not.Aside from diversification, there are some other tools to look for.Pension funds you can buy generally track inflation, as do someother investments. This is a sort of guarantee that inflation will not

outpace your funds.


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Whatever your strategy, be aware of the inflation rate and makesure you are keeping up with it, if not surpassing it, in yourinvestments and other earnings. And be sure to talk to your eldersabout these concepts, which may be foreign to them. Older people

tend to prefer safe investments but make sure they are not beingso safe that they lose money! Once their earning power is gone,they need the money more than anyone else.

Effect on indian economy

A low inflation rate is beneficial to a country and zero ornegative inflation is considered as bad. Also, a high inflationis harmful to an economy and it affects an economy in manyways.

High inflation distorts consumer behavior. Because of thefear of price increases, people tend to purchase their


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requirements in advance as much as possible. This candestabilize markets creating unnecessary shortages.

High inflation redistributes the income of people. The fixedincome earners and those lacking bargaining power willbecome relatively worse off as their purchasing power falls.

Trade unions may demand for higher wages at times of highinflation. If the claims are accepted by the employers, it maygive rise to a wage-price spiral which may aggravate the

inflation problem.During a high inflation period, wide fluctuations in the inflationrate make it difficult forbusiness organizations to predict thefuture and accurately calculate prices and returns from

investments. Therefore, it can undermine businessconfidence.
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When inflation in a country is more than that in a competitivecountry, the exports from former country will be less attractivecompared to the other country. This means there will be lesssales for that countrys goods both at home and abroad and

that will create a larger trade deficit. At the same time, highinflation in a country weakens its competitive position in theinternational market.

HOW INFLATION IS MEASURED? Inflation is normally

given as a percentage and generally in yearsor in some

i l d i d i d h i


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instances quarterly and is derived from the Consumer PriceIndex (CPI).However, there are two main indices used tomeasure inflation.The f irst is the Consumer P rice Index,or the CPI . The CPI is ameasure of the price of a set group

of goods and services. The"bundle ," as the group isknown, contains items such as food,clothing, gasoline, andeven computers. The amount of inflation ismeasured by thechange in the cost of the bundle: if it costs 5%more to

purchase the bundle than it did one year before, therehasbeen a 5% annual rate of inflation over that period based ontheCPI . You wi l l a l so of ten hear about the "Core Rate"or the"Core CPI." There are certain items in the bundle usedto measurethe CPI that are extremely volatile, such as

gasoline prices. By eliminating the items that can significantlyaffect the cost of thebundle (in either direction) on a month-

h b i h C i h h b b i di


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to-month basis, the Corerate is thought to be a better indicatorof real inflation, the slow,but steady increase in the price of goods

and services. The second measure of inflation is the Producer Price

Index, or thePPI. While the CPI indicates the change in the

purchasing power of a consumer, the PPI measures the change in

the purchasing power of the producers of those goods. The

PPI measures how much producers of products are getting

on the wholesale level, i.e. the price at which a good is sold to

other businesses before the good is sold to a consumer.The PP I actua ll y comb in e s a se r ie s of smaller indices that

cross many industries and measure the pricesfo r t h r e e t y p e s

o f g o o d s : c r u d e , i n t e r m e d i a t e a n d

f i ni s h e d . General ly, the markets are most concernedwith the finis hed goods because these are a strong

d f h ll h h f h


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indicator of what will happenwit h future CPI reports. The

CPI is a more popular measure of inflation than the PPI, but

investors watch both closely

TYPES OF INFLATION:

S b l h i h h i f d i


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Subsequently, when either the prices of goods or services orthesupply of money rises; this is considered as inflation.Dependingon the characteris tics and the intens ity ofinflation, there are several types, namely.

Creeping inflationTrotting inflation

Galloping inflationHyper inflation


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When there is a general rise in prices at very low rates,which isusually between 2-4 percent annually, this isknown as creepinginflation.Whereas, trotting inflation occurs

when the percentage has risenfrom 5 to almost percent. Atthis level it is a warning signal for most governments to takemeasures to avoid exceeding double-digit figures. Another typeof inflation is the galloping inflation, where the rateof inflation

is increasing at a noticeable speed and at a remarkablerate, usuallyfrom 10-20 percent.However, when the inflation rate rises toover 20% it is generally c o n s i d e r e d a s h y p e r i n f l a t i o nand at this stage i t is almost uncontrol lable because i tincreases more rapidly in such a littletime frame.


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The main difference between the galloping and hyper inflation,is


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that hyperinflation occurs when prices rise at any moment

and there is no level to which the prices might rise.D u r i n g

W o r l d W a r I I c e r t a i n c o u n t r i e s

e x p e r i e n c e d a h y p e r i n f l a t i o n , w h e r e t h e p r i c e

i d f 1 t 1 000 000 000 i


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i n d e x r o s e f r o m 1 t o o v e r 1,000,000,000 in

Germany during January 1922 to Novembe r 1923.

CAUSES OF INFLATION

Inflation comes in different forms and those at are familiarwiththe economic matters would observe that there are trendsin theway that prices are moving gradual and irregular inrelation toaggregate sections of the economy. This

suggest that there i smor e tha n on e fa c to r tha t ca us esin f l at io n an d as di ff er e nt sections of the economydevelop it gives r ise to different types inflationary periods. Themain causes of inflation are:

Demand-pull Inflation

Cost push InflationMonetary inflation

St t l i fl ti


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Structural inflationImported inflation

DEMAND-PULL INFLATION

Demand-pull inflation occurs when the consumers, businesses

or the governments demand for goods and services

exceed thesupply; theref ore the cost of the i tem

rises , un less supply i s perfect ly e last i c . Because we

do no t li ve in a pe rfec t mar ket supply is somewhat

inelastic and the supply of goods and servicescan only be

increased if the factors of production are increased.The increase in

demand is created from in increase in other areas,such as thesupply of money, the increase of wages which would then give

i i di bl i d th h


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rise in disposable income, and once the consumers havemore

disposal income this would lead to aggregate spending. As a result

of the aggregate spending there would also be an increasein

demand for exports and possible hoarding and profiteeringfrom producers. The excessive demand, the prices of final

goods and services would be forced to increase and this

increase gives riseto inflation.

COST-PUSH INFLATION

Cost-push inflation is caused by an increase in production costs. It isgenerally caused by an increase in wages or an increase in the profit

margins of the entrepreneurs When wages are increased this causes


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margins of the entrepreneurs.When wages are increased, this causes

the business owner to inturn increase the price of final goods and

services which would be passed onto the consumers and the same

consumers are also theemployees. As a result of the increase in pricesfor final goods and services the employees realise that their income is

insufficient tomeet their standard of living because the basic cost of

l iving hasincreased. The trade unions then act as the

m ed ia to r fo r t he e m p l o y e e s a n d n e g o t i a t e b e t t e r

wages and conditions of employment. If the negotiations are

successful and the employeesare given the requested wage increase

this would further affect the prices of goods and services and

invariably affected.On the other hand, when firms attempt to

increase their profit margins by making the prices more responsive

to supply of a good or service instead of the demand for that said


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to supply of a good or service instead of the demand for that said

good or service.This is usually done regardless to the state of the

economy.

MONETARY INFLATION

Monetary inflation is a sustained increase in the money supply of

a country. It usually results inprice inflation, which is a rise in thegeneral level of prices of goods and services. Originally the term"inflation" was used to refer only to monetary inflation, whereas inpresent usage it usually refers toprice inflation.[1]

There is general agreement among economists that there is a causalrelationship between the supply and demand of money, and pricesof goods and services measured in monetary terms, but there is no

overall agreement about the exact mechanism and relationship
http://en.wikipedia.org/wiki/Money_supplyhttp://en.wikipedia.org/wiki/Price_inflationhttp://en.wikipedia.org/wiki/Price_inflationhttp://en.wikipedia.org/wiki/Monetary_inflation#cite_note-1http://en.wikipedia.org/wiki/Supply_and_demandhttp://en.wikipedia.org/wiki/Supply_and_demandhttp://en.wikipedia.org/wiki/Monetary_inflation#cite_note-1http://en.wikipedia.org/wiki/Price_inflationhttp://en.wikipedia.org/wiki/Price_inflationhttp://en.wikipedia.org/wiki/Money_supply


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overall agreement about the exact mechanism and relationshipbetween price inflation and monetary inflation. The system iscomplex and there is a great deal of argument on the issuesinvolved, such as how to measure the monetary base, or how much

factors like the velocity of money affect the relationship, and whatthe best monetary policy is. However, there is a general consensuson the importance and responsibility of central banks and monetaryauthorities in affecting inflation. Keynesian economists favor

monetary policies that attempt to even out the ups and downs of thebusiness cycle. Currently, most central banks follow such a rule,adjusting monetary policy in response to unemployment andinflation (see Taylor rule). Followers of the monetarist schooladvocate eitherinflation targeting or a constant growth rate of

money supply, while Austrian economists advocate the return to

free markets in money which would entail free banking or a return
http://en.wikipedia.org/wiki/Monetary_basehttp://en.wikipedia.org/wiki/Velocity_of_moneyhttp://en.wikipedia.org/wiki/Monetary_policyhttp://en.wikipedia.org/wiki/Business_cyclehttp://en.wikipedia.org/wiki/Unemploymenthttp://en.wikipedia.org/wiki/Taylor_rulehttp://en.wikipedia.org/wiki/Monetarismhttp://en.wikipedia.org/wiki/Inflation_targetinghttp://en.wikipedia.org/wiki/Austrian_economicshttp://en.wikipedia.org/wiki/Austrian_economicshttp://en.wikipedia.org/wiki/Inflation_targetinghttp://en.wikipedia.org/wiki/Monetarismhttp://en.wikipedia.org/wiki/Taylor_rulehttp://en.wikipedia.org/wiki/Unemploymenthttp://en.wikipedia.org/wiki/Business_cyclehttp://en.wikipedia.org/wiki/Monetary_policyhttp://en.wikipedia.org/wiki/Velocity_of_moneyhttp://en.wikipedia.org/wiki/Monetary_basehttp://en.wikipedia.org/wiki/Free_markethttp://en.wikipedia.org/wiki/Free_bankinghttp://en.wikipedia.org/wiki/Free_bankinghttp://en.wikipedia.org/wiki/Free_market


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free markets in money, which would entail free banking or a returnto a 100 percent gold standard and the abolition ofcentral banks.

STRUCTURAL INFLATION

Inflation of an economic system that results from themonetary policy pursued by a country's government.Structural inflation will have a bearing on the decisions madeby forex traders regarding the currency linked to thateconomic system.

IMPORTED INFLATION

Inflation due to an increase in the price ofimports. As the price ofimports increase,prices ofdomesticgoods using imports as raw

materials also increase, causing an increase in the general prices of

all goods and services Imported inflation may be caused by foreign
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all goods and services. Imported inflation may be caused by foreignprice increases ordepreciation of a country's exchange rate.

EFFECT OF INFLATION SHOWN IN GRAPH
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EFFECT OF INFLATION ON INDIA


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EFFECT OF INFLATION

Inflation can have positiveand negativeeffects on an economy .

Negative effects of inflation include loss in stability in the realvalueof money and other monetary items over time; uncertainty aboutfuture inflation may discourage investment and saving, and highinflation may lead to shortages ofgoodsif consumers

beginhoardingout of concern that prices will increase in thefuture.Positive effects include a mitigation of economicrecessions,and debt reliefby reducing the real level of debt.Most effects of

inflation are negative and can hurt individuals and companies
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inflation are negative, and can hurt individuals and companiesalike, below are a list of negative and positive effectsof inflation:

NEGATIVE EFFECTS OF INFLATION

1. Causes an increase in tax bracket (people will be taxed ahigherpercentage if their income increases following aninflation

increase).

2. Causes mal-investment (in inflation times, the data givenaboutan investment is often deceptive and unreliable,thereforecausing losses in investments).

3. Causes business cycles (many companies will have to go out ofbusiness because of the losses they incurred from inflationandits effects)

4 Rising prices of imports (if the currency is debased then


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4. Rising prices of imports (if the currency is debased, thenits purchasing power in the international market is lower).

"POSITIVE" EFFECTS OF INFLATION ARE:

1. It can benefit the inflators (those responsible for the inflation)

2. It be benefit early and first recipients of the inflated money (because

the negative effects of inflation are not there yet)

3. It can benefit the cartels (it benefits big cartels, destroyssmallsellers, and can cause price control set by the cartelsfor their

4 It might relatively benefit borrowers who will have to pay


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4. It might relatively benefit borrowers who will have to paythesame amount of money they borrowed (+ fixed interests),butthe inflation could be higher than the interests, thereforetheywill be paying less money back. (example, you borrowed $1000

in 2005 with a 5% fixed interest rate and you paid it back in fullin 2007, lets suppose the inflation rate for 2005,2006 and 2007has been 15%, you were charged %5 of interests, but in reality,you were earning %10 of interests,because 15% (inflation rate)

5% (interests) = %10 profit,which means you have paid only70% of the real value in the3 years.Note: Banks are aware ofthis problem, and when inflationrises, their interest rates mightrise as well. So don't take out loans based on this information.

5. Many economists favor a low steady rate of inflation, low

(asopposed to zero or negative) inflation may reduce theseverityof economic recessions by enabling the labor market to adjust

more quickly in a downturn and reducing the risk that a


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more quickly in a downturn, and reducing the risk that aliquidity trap prevents monetary policy from stabilizingtheeconomy. The task of keeping the rate of inflation lowand stableis usually given to monetary authorities.Generally, these

monetary authorities are the central banksthat control the size ofthe money supply through the settingof interest rates, throughopen market operations, and through the setting of bankingreserve requirements

6. To bin effect argues that: a moderate level of inflationcanincrease investment in an economy leading to faster growth

or at least higher steady state level of income. This is due to the

fact that inflation lowers the return on monetary assets relative

to real assets, such as physical capital. To avoid inflation,

investors would switch from holding their assets as money (or a


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of money supply by devising appropriate mo netary


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of money supply by devising appropriate mo netary

po li cy and careful ly implementing such measures. To

control inflation, it is necessary to control total

expenditures because under conditions offullemployment, increase in total expenditures will be

reflected in ageneral rise in prices, that is, inflation. Monetary

policy is used tocontrol inflat ion and is bas ed on the

assumpt ion that a r ise in pr i ce s i s du e to ex ce ss of

m o n e t a r y d e m a n d f o r g o o d s a n d services by the

consumers/households e because easy bank credit is available to

them. Monetary policy, thus, pertains to bankingand credit

availability of loans to firms and households,

interest r a t e s , p u b l i c d e b t a n d i t s m a n a g e m e n t , a n d

t h e m o n e t ar y standard. Monetary management is


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t h e m o n e t ar y standard. Monetary management is

ai med at the co mmercialbanking systems, and through this

action, its effects are primarily felt in the economy as a whole.

By directly affecting the volume of cash reserves of the banks,can regulate the supply of money and c r e d i t i n t h e

e c o n o m y , t h e r e b y i n f l u e n c i n g t h e s t r u c t u r e

o f interest rates and the availability of credit. Both these,

factors af fect t he co mponents of a ggrega te de mand

and the f l ow of expenditure in the economy. The central

banks monetary management methods, the devicesfor

decreasing or increasing the supply of money and credit

for monetar y stabi l i ty i s ca l led monet ary po l icy .

Ce nt ra l b ank sgeneral ly use the three quantitative

measures to control thevolume of credit in an economy,


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measures to control thevolume of credit in an economy,

namely:

1.Raising bank rates

2.Open market operations and

3.Variable reserve ratio

However, there are various limitations on the effective working

of the quantitative measures of credit control adapted by the

centralbanks and, to that extent, monetary measures to control

inflationare weakened. In fact, in controlling inflation moderate

monetary measures, by themselves, are relatively ineffective. On the

other hand, drastic monetary measures are not good for the

economicsystem because they may easily send the economy into a


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eco o csyste because t ey ay eas y se d t e eco o y to a

decline.In a developing economy there is always an increasing

need for credit. Growth requires credit expansion but to check

inflation,there is need to contract credit. In such an encounter,the best course is to resort to credit control, restricting the flow

of credit into the unproductive, inflation-infected sectors and

speculativeactivitie s, and di versify ing the flow of credi t

towards the most desirable needs of productive and growth-inducingsector. It should be noted that the impression that the rate of

spendingcan be controlled rigorously by the contraction of credit or

money supply is wrong in the context of modern economic

societies. Inmodern community, tangible, wealth is typically

represented by claims in the form of securities, bonds, etc., or

near moneys, asthey are called. Such near moneys are highly


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y , y y g y

liquid assets, and they are very close to being money. They

increase the generall iq ui dit y of th e ec ono my . In th ese

ci rc um st an ce s, it is no t so simple to control the rate ofspending or total outlays merely by controlling the quantity of

money. Thus, there is no immediateand direct relationship

between money supply and the price level,as is normally conceived by

the traditional quantity theories.When there is inflation in an economy,monetary restraints can, inconjunction with other measures, play a

useful role in controlling inflation.

FISCAL MEASURES

Fiscal policy is another type of budgetary policy in


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p y yp g y p y

relation totaxation, public borrowing, and public

expenditure. To curve theeffects of inflat ion and changes

in the total expenditure, f iscalmea sur es wo uld ha ve t obe implemented whic h involves an increase in taxation and

decrease in government spending. Duringinflationary periods the

government is supposed to counteract anincrease in private

spending. It can be cleared noted that during a period of ful lemployme nt inf lati on, the agg regate demand in elation

to the limited supply of goods and services is reduced tothe

extent that government expenditures are shortened. Along with

public expenditure, governments must

simultaneously increase taxes that would effectively reduce

private expenditure,in an effect to minimise inflationary


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p p , y

pressures. It is known that when more taxes are imposed,

the size of the disposable incomediminishes, also the

magnitude of the inflationary gap in regardsto the availability ofthe supply of goods and services. I n s o m e i n s t a n c e s , t a x

p o l i c y h a s b e e n d i r e c t e d t o w a r d s restricting

demand without restricting level of production.

For example, excise duties or sales tax on variouscommodities may take away the buy ing power from the

consumer goods market without discouraging the level

of product ion. However, someeconomists point out that

this is not a correct way of combatinginflat ion because it

may lead to a regressive status within theeconomy. As a

result, this may lead to a further rise in prices of goods


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, y p g

and services, and inflation can spread from one sector of the

economy to another and from one type of goods and services to

another.Therefore, a reduction in public expenditure, andan increase intaxes produces a cash surplus in the budget.

Keynes, however,suggested a programme of compulsory

savings, such as deferred pay as an anti-inflationary measure.

Additionally, private savings have a strong disinflationary effectonthe economy and an increase in these is an important measure

for controlling inflation. Government policy should therefore,

includedevices for increasing savings. A strong savings drive

reduces thespendable income of the consumers, without any

harmful effectsof any kind that are associated with higher

taxation.Furthermore, the effects of a large deficit budget,


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, g g ,

which is mainly responsible for inflation, can be partially

offset by covering thedeficit through public borrowings. It

should be noted that it is only g o v e r n m e n t b o r r o w i n gf rom non-bank l e nde rs that has ad i s i n f l a t i onary

effect. In addition, public debt may be managed ins u c h a

w a y t h a t t h e s u p p l y o f m o n e y i n t h e c o u n t r y m a y

b e controlled. The government should avoid paying backany of its past loans dur ing inf lationa ry periods, in ord er

to prevent anincrease in th e c i rc ulat ion of mo ney.

Ant i -i nf lat io na r y de bt management also includes

cancellation of public debt held by thecentral bank out of a

budgetary surplus. Fisca l policy by itse lf may not be very

ef fe ct ive in co mbat ing inflation; therefore a combination of


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g

fiscal and monetary tools canwork together in achieving the

desired outcome.

DIRECT MEASURES OF CONTROL


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In times of the severe scarcity of certain goods, particularly,

food grains, g overnme nt may have to enf orce rat ioni ng,

along with p r i c e c o n t r o l . T h e m a i n f u n c t i o n o f

r a t i o n i n g i s t o d i v e r t consumption from those

commodities whose supply needs to bere s t r i c t e d f o r

s o m e s p e c i a l r e a s o n s ; s u c h a s , t o m a k e

thecommodity more available to a larger number of

households.Therefore, rationing becomes essential when

necessities, such asfood grains, are relat ively scarce.Rationing has the effect of l imiting the variety of

quantity of goods available for the good cause of price


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stabil ity and distributive impartial ity.

However,according to Keynes, rationing involves a great

deal of waste,both of resources and of employment. In timesof the severe scarcity of certain goods, particularly,

food grains, g overnme nt may have to enf orce rat ioni ng,

along with p r i c e c o n t r o l . T h e m a i n f u n c t i o n o f

r a t i o n i n g i s t o d i v e r t consumption from thosecommodities whose supply needs to bere s t r i c t e d f o r

s o m e s p e c i a l r e a s o n s ; s u c h a s , t o m a k e

thecommodity more available to a larger number of

households.Therefore, rationing becomes essential when

necessities, such asfood grains, are relat ively scarce.

Rationing has the effect of l imiting the variety of


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quantity of goods available for the good cause of price

stabil ity and distributive impartial ity.

However,according to Keynes, rationing involves a greatdeal of waste,both of resources and of employment.

corrections through periodic adjustments in money incomes ofthe people and in the val ues of f inanc ial as sets s uch

as sa vin gs deposits, which are held by them in relationto the degrees of price rise. Basically, if the annual pricewere to rise to 20%, themoney incomes and values offinancial assets are enhanced by 20%, under the system ofindexing.Indexing also saves the government from public

wrath due tosevere inflation persisting over a long period.Critics, however, donot favour indexing, as it does not


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when the total expenditure o f t h e c o m m u n i t y i s n o t


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e q u a l t o t h e e x i s t i n g p r i c e s . Consequently, the

supply of money decreases and as a result p r i c e s f a l l .

D e f l a t i o n c a n a l s o b e b r o u g h t a b o u t b y

d i r e c t c ontrac t i ons i n s pe nd ing , ei the r i n the f orm

of a reduction ingovernment spending, personal spending or

investment spending.D e f l a t i o n h a s o f t e n h a d t h e

s i d e e f f e c t o f i n c r e a s i n g unemployment in an

economy, since the process often leads to alower level ofdemand in the economy. However, each and every fall in

price cannot be called deflation. The process of

reversinginflation without either creating unemployment or

reducing output is called disinflation and not deflation.


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STAGFLATION

Stagflation is a stagnant economy that is combined with

inflation.Basically, when prices are increasing the economy is

deceasing.Some economists believe that there are two main

reasons for stagflation. Firstly, sta gflation can occur when an

economy isslowed by an unfavourable supply, such as an

increase in the price of oil in an oil importing country, which tends

to raise pricesat the same time that it slows the economy by making

productionless profitable. In the 1970's inflation and recession

occurred indifferent economies at the same time. Basically, whathappened was that there was plenty of liquidity in the system

and peoplewere spending money as qu ickly as t hey got it


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because priceswere going up quickly. This gav e rise to the

second reason for stagflation.

project report on inflation new

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