What is Inflation?
As per the International Monetary Fund, inflation refers to the speed at which prices increase during a specific period, encompassing a thorough evaluation of general price increases as well as those specific to certain goods and services. It reflects the rising costs linked to everyday existence and showcases the degree to which a particular assortment of products and/or services has become more expensive over a defined timeframe, usually one year.
In the Indian context, inflation assumes significant significance due to its amplification by economic disparities and a large population.
Causes of Inflation
| Demand-Pull Inflation: | Demand-pull inflation occurs when aggregate demand in an economy is more than aggregate supply. It involves inflation rising as real gross domestic product rises and unemployment falls, as the economy moves along the Phillips curve. This is commonly described as “too much money chasing too few goods”. A booming economy with high consumer spending can create excess demand, putting upward pressure on prices. |
| Cost-Push Inflation: | Cost-push inflation is driven by an increase in the production costs for goods and services. This can be caused by several factors like increased incomes, increased costs of raw materials, or disruptions in the supply chain due to national and international events like war ( recent Russia-Ukraine war). In Such condition inflation caused by increases in the cost of important goods or services. |
| Built-In or Wage-Price Inflation: | The wage-price spiral is a macroeconomic theory explaining the cause-and-effect relationship between rising wages and prices, or inflation. As rising wages increase disposable income, demand for goods rises, triggering prices for goods to move higher. Rising prices then increase demand for higher wages, which leads to higher production costs and further upward pressure on prices, creating a conceptual spiral. This type of inflation is often described as a feedback loop between wages and prices. For Example Suppose, When workers demand higher wages, businesses may raise prices to cover the increased labor costs. This, in turn, prompts workers to seek higher wages, and the cycle continues. Collective bargaining by labor unions can result in higher wages, leading to increased production costs and subsequently higher prices for goods and services. |
What has Caused Inflation in India in Recent Years?
- Significant supply interruptions played a major role in fueling inflation during the two waves of the Covid-19 pandemic.
- The start of the pandemic, lockdowns measures led to a substantial decrease in both production and consumer demand, ultimately resulting in a sharp decline in overall economic expansion.
- This phase also saw a decrease in commodity prices due to weakened demand.
- As the economy gradually reopened with the distribution of vaccines and the release of pent-up consumer demand, the recovery in demand surpassed the recovery in supply. This imbalance resulted in rising pressures on commodity prices.
- Russia-Ukraine conflict in 2022 further intensified supply chain challenges and added to commodity price pressures.
What is the Methodology for Assessing Inflation Causes?
- Unanticipated changes in prices and quantities during a month ascertain whether inflation is driven by demand (prices and quantities moving together) or by supply (prices and quantities moving in opposite directions).
- When there is a surge in the desire for a product, it has an impact on the escalation of both the cost and the quantity. Conversely, when there is a decline in demand, it leads to a decrease in both the price and the quantities.
- Inflation is deemed as being driven by supply if there is an unforeseen alteration in prices and quantities that go in contrary directions. In such a scenario, a reduction in supply is connected with a decline in volume while witnessing a rise in price, and vice versa.
- Demand and supply factors at the sub-group level were combined using the CPI weights to assess overall headline inflation.
- Headline inflation is a measure of the total inflation within an economy, including commodities such as food and energy prices, which tend to be much more volatile and prone to inflationary spikes.
- The headline inflation figure is reported through the Consumer Price Index (CPI), which calculates the cost to purchase a fixed basket of goods to determine how much inflation is occurring in the broad economy.
| UPSC Civil Services Examination, Previous Year Question (PYQ) Q.1 With reference to Indian economy, demand-pull inflation can be caused/increased by which of the following? (2021) 1. Expansionary policies 2. Fiscal stimulus 3. Inflation-indexing of wages 4. Higher purchasing power 5. Rising interest rates Select the correct answer using the code given below: (a) 1, 2 and 4 only (b) 3, 4 and 5 only (c) 1, 2, 3 and 5 only (d) 1, 2, 3, 4 and 5 Ans: (a) Q.2 Consider the following statements: (2020) 1. The weightage of food in Consumer Price Index (CPI) is higher than that in Wholesale Price Index (WPI). 2. The WPI does not capture changes in the prices of services, which CPI does. 3. The Reserve Bank of India has now adopted WPI as its key measure of inflation and to decide on changing the key policy rates. Which of the statements given above is/are correct? (a) 1 and 2 only (b) 2 only (c) 3 only (d) 1, 2 and 3 Ans: (a) Q 3. If the RBI decides to adopt an expansionist monetary policy, which of the following would it not do? (2020) 1. Cut and optimize the Statutory Liquidity Ratio 2. Increase the Marginal Standing Facility Rate 3. Cut the Bank Rate and Repo Rate Select the correct answer using the code given below: (A) 1 and 2 only (B) 2 only (C) 1 and 3 only (D) 1, 2 and 3 Ans: B |