We all have heard of the word inflation. Matter of fact is that these days we find this word all around us. Recently we had an all India bandh by the opposition parties to protest against inflation, mainly against the rising prices of the fuel. So what exactly is inflation?
What is it?
In simple terms inflation is the increase in the price of a commodities and services. Pani puri which we used to get 4 pieces for Re 1 few years back, now costs Rs 10 for 6 pieces. It is a phenomenon by which cost of goods and services go up as time passes. In polished language, inflation is the decrease in purchasing power of a monetary unit.
The term deflation is just the opposite of inflation. We call the phenomena of decrease in prices as time passes as deflation. Deflation is a situation rarely seen in growing economy. Every year we find the things getting dearer.
How is it Calculated?
Most country's central banks try to sustain an inflation rate of 2-3% which is the ideal scenario. Excessive inflation and deflation both are detrimental to a nation's economy. Forecasting inflation is very difficult and it is determined using various indices. The two main indices used for it are -
What is it?
In simple terms inflation is the increase in the price of a commodities and services. Pani puri which we used to get 4 pieces for Re 1 few years back, now costs Rs 10 for 6 pieces. It is a phenomenon by which cost of goods and services go up as time passes. In polished language, inflation is the decrease in purchasing power of a monetary unit.
The term deflation is just the opposite of inflation. We call the phenomena of decrease in prices as time passes as deflation. Deflation is a situation rarely seen in growing economy. Every year we find the things getting dearer.
How is it Calculated?
Most country's central banks try to sustain an inflation rate of 2-3% which is the ideal scenario. Excessive inflation and deflation both are detrimental to a nation's economy. Forecasting inflation is very difficult and it is determined using various indices. The two main indices used for it are -
- Wholesale Price Index(WPI) - It is the index that is used to measure the change in the average price level of goods traded in wholesale market. In India prices of around 500 commodities is tracked through WPI. India uses this WPI to calculate inflation.
- Consumer price index(CPI) - It a measure estimating the average price of consumer goods and services purchased by households. As this measures the prices paid by the consumer this index gives a more realistic idea of the inflation. Most of the developed countries today use this index to calculate inflation.
What leads to inflation?
- Demand is greater than Supply - When demand is more than supply, there are more people chasing the limited amount of product, so the person who is capable of paying more, gets the product by paying more. To control these, governments sometimes put caps on the prices of goods. This scenario might lead to black markets where goods are illegally sold at a price higher than the cap. Sometimes this situation is created by the suppliers in a monopoly so that they get more return for their goods. The inflation in prices of oil and fuel is one such example. The Middle East countries have been supplying the fuel in controlled amount so that the demand always exceeds supply which leads to inflation in prices of these every year.
- Unchecked growth of economy- This point is similar to the above one, but it happens when the economy is expanding at rapid pace. As economy expands, more money is circulated in the market. People need more money to buy more products. This leads to increase in selling by the producers which in turn leads to increase in wages which creates more money. As demand continues to increase, the producers tend to increase the prices, which eventually leads to inflation.
- Excessive supply of money - Sometimes economy gets very dull and people do not spend. In such situation the government tries to revive the economy by increasing the money supply. More money leads to decrease in its value, lowering its purchasing power.
How does it affect us?
Inflation has more of a macroeconomic effect. In the short run it tends to affect every individual but in the longer run it tends to even out with the increase in wages and profits. We need to keep this in mind when we plan for our future savings and retirement plans because it might happen that the same amount of money would hold no value then, say 25 years from now. In the longer run the effect is felt more at the higher level, on the entire economy. Due to inflation the purchasing power of a currency decreases which in turn leads to fall in its value in the international market.
How to curb it?
Its important for a economy to grow, and if there is growth inflation is bound to be there. So the ideal scenario that any economy would want is low levels of inflation. The most important tool used by most central banks is base interest rate. Supply of money plays an important role in determining overall inflation. Supply of money can be regulated by the base interest rate. If inflation is high, interest rates are increased which leads to less borrowing and more savings which results in lesser supply of money in the market which in turn keeps the prices in check. If the economy is dull and inflation rates are low, interest rates are decreased to stimulate the supply of money thus reviving the economy.
Inflation has more of a macroeconomic effect. In the short run it tends to affect every individual but in the longer run it tends to even out with the increase in wages and profits. We need to keep this in mind when we plan for our future savings and retirement plans because it might happen that the same amount of money would hold no value then, say 25 years from now. In the longer run the effect is felt more at the higher level, on the entire economy. Due to inflation the purchasing power of a currency decreases which in turn leads to fall in its value in the international market.
How to curb it?
Its important for a economy to grow, and if there is growth inflation is bound to be there. So the ideal scenario that any economy would want is low levels of inflation. The most important tool used by most central banks is base interest rate. Supply of money plays an important role in determining overall inflation. Supply of money can be regulated by the base interest rate. If inflation is high, interest rates are increased which leads to less borrowing and more savings which results in lesser supply of money in the market which in turn keeps the prices in check. If the economy is dull and inflation rates are low, interest rates are decreased to stimulate the supply of money thus reviving the economy.
No comments:
Post a Comment