Inflation

Notes

Inflation is a sustained rise in the general price level of goods and services, which reduces the purchasing power of money. It is measured by the percentage change in a price index over a year.

Types by rate

Creeping (1-3%), walking/trotting (3-10%), running (10-20%) and galloping/hyperinflation (above 20% a year; extreme cases such as Weimar Germany in 1923 and Zimbabwe).

Causes

Demand-pull inflation: aggregate demand exceeds aggregate supply ("too much money chasing too few goods").
Cost-push inflation: a rise in input costs (wages, oil, raw materials, taxes) pushes up prices; supply shocks.
Structural inflation: supply bottlenecks in agriculture and infrastructure. Imported inflation: higher import prices or a falling currency. Built-in (wage-price) inflation through expectations.

Related terms

Stagflation: high inflation with stagnant growth and high unemployment (the 1970s oil shocks).
Reflation: policy to raise prices and output after deflation. Skewflation: price rise in a specific group of commodities while others are stable.
Phillips curve (A.W. Phillips, 1958): a short-run trade-off between inflation and unemployment.

Effects

Hurts fixed-income earners, savers and creditors; benefits debtors and those with real assets; raises the cost of living; reduces export competitiveness; distorts investment.

Control measures

Monetary: raise repo rate, CRR/SLR, open market operations.
Fiscal: cut government spending and the fiscal deficit, raise taxes.
Supply-side: buffer stocks, imports, stock limits under the Essential Commodities Act, 1955, improved storage and supply chains.

India's inflation targeting

Flexible Inflation Targeting (FIT) was adopted through the 2016 amendment of the RBI Act (the Urjit Patel Committee, 2014). The target is 4% CPI inflation with a tolerance band of +/-2% (2-6%), reviewed every five years by the Government in consultation with the RBI.
The Monetary Policy Committee (MPC) sets the policy rate to meet the target. If inflation stays outside the band for three consecutive quarters, the RBI must send a report to the Government explaining the reasons and remedial action.

Key Points

Inflation: sustained rise in the price level; reduces purchasing power.
Demand-pull vs cost-push; stagflation = inflation + stagnation.
Phillips curve: inflation-unemployment trade-off.
Controls: monetary, fiscal, supply-side.
India: 4% target with a +/-2% band (CPI); MPC; failure after three quarters.

MCQs

Q1. Inflation caused by a rise in the cost of production inputs is called:
(a) Demand-pull inflation
(b) Cost-push inflation
(c) Hyperinflation
(d) Reflation
Ans: (b) .

Q2. India's inflation target (CPI) under the flexible inflation targeting framework is:
(a) 2% +/- 2%
(b) 4% +/- 2%
(c) 5% +/- 1%
(d) 6% +/- 2%
Ans: (b) .

Q3. Stagflation refers to:
(a) Falling prices with growth
(b) High inflation with high unemployment and stagnant growth
(c) A fall in inflation rate
(d) Rising growth with low prices
Ans: (b) .