INFLATION AND DEFLATION

IMPACT ON THE ECONOMY

Inflation & Deflationimpact on economy

Major outlines

Introduction Definition Types of Inflation/deflation Causes of Inflation/deflation Effects of Inflation/deflation

Intro……………

Situation of rapid general increase in price level.

Decline in the value of money.

Definitions: According to Crowthers “ Inflation

means a state in which the value of money is falling i.e.… prices are rising”.

In the words of Gardner Ackley, "Inflation is a persistent and appreciable rise in the general level or average of prices."

According to Prof. Samuelson “ Inflation occurs when general level of prices & cost are rising”.

Types of inflation

Creeping inflation—At about 3% Walking inflation—more than 10% Running inflation—about 100% Galloping inflation or Hyper inflation

Cont…

Demand – pull inflation: Due to high GDP and low unemployment.

Supply shock or cost push inflation:

due to adverse change in price of raw materials ( like oil).

Built in inflation: induced by expectations based on

previous inflation levels.

Causes of inflation

Increases in money supply. Expansion of bank credit. Deficit financing. Black money. Scarcity. Taxes. Population growth.

Effect of Inflation

Debtors and creditors. People with fixed income. Consumers . Producers and businessman. Farmers.

Deflation

A general decline in price often caused by a reduction in the supply of money or credit.

Deflation can be caused also by decrease In government , personal or investment spending.

Deflation has the side effect of increased unemployment.

Causes of deflation

Decreasing money supply.

Increasing supply of goods.

Decreasing demand of goods.

Increasing demand for money.

Effect on economy as well as our self

Inflation affects you directly when you go to the grocery store but find that a hundred dollars doesn't get you the same amount as it did last year.

Many people hang on to their money & stop spending on many non-essential items because of fear.

Houses & Cars begin to depreciate.

Cont…

Business starts to dry up & employers find themselves cutting down on staff.

Our fixed income gets depleted & we find ourselves having to survive on even less.

The quality or standard of life that many have grown, downgrades as a direct result of inflation.

How to control Inflation?

There are broadly two ways of controlling inflation in an economy:

1). Monetary measures and

2). Fiscal measures

I).Monetary MeasuresThe most important and commonly used method to control inflation is monetary policy of the Central Bank. Most central banks use high interest rates as the traditional way to fight or prevent inflation.

Monetary measures used to control inflation include:(i) bank rate policy(ii) cash reserve ratio and(iii) open market operations.

Bank rate policy is used as the main instrument of monetary control during the period of inflation. When the central bank raises the bank rate, it is said to have adopted a dear money policy. The increase in bank rate increases the cost of borrowing which reduces commercial banks borrowing from the central bank. Consequently, the flow of money from the commercial banks to the public gets reduced. Therefore, inflation is controlled to the extent it is caused by the bank credit. 

Cash Reserve Ratio (CRR) : To control inflation, the central bank raises the CRR which reduces the lending capacity of the commercial banks. Consequently, flow of money from commercial banks to public decreases. In the process, it halts the rise in prices to the extent it is caused by banks credits to the public.

Open Market Operations: Open market operations refer to sale and purchase of government securities and bonds by the central bank. To control inflation, central bank sells the government securities to the public through the banks. This results in transfer of a part of bank deposits to central bank account and reduces credit creation capacity of the commercial banks.

II). Fiscal MeasuresFiscal measures to control inflation include taxation, government expenditure and public borrowings. The government can also take some protectionist measures (such as banning the export of essential items such as pulses, cereals and oils to support the domestic consumption, encourage imports by lowering duties on import items etc.).

Disinflation is a decrease in the rate of inflation – a slowdown in the rate of increase of the general price level of goods and services in a nation's gross domestic product over time. It is the opposite of reflation.

Reflation is the act of stimulating the economy by increasing the money supply or by reducing taxes. It is the opposite of disinflation. It can refer to an economic policy whereby a government uses fiscal or monetary stimulus in order to expand a country's output. Just as disinflation is considered an acceptable antidote to high inflation, reflation is considered to be an antidote to deflation (which, unlike inflation, is considered bad regardless how high it is).

In economics, stagflation is a situation in which the inflation rate is high and the economic growth rate is low. . It raises a dilemma for economic policy since actions designed to lower inflation may worsen economic growth and vice versa.It is a condition of slow economic growth and relatively high unemployment - a time of stagnation - accompanied by a rise in prices, or inflation.

Thank you