Ramesh Singh Test: Inflation & Business Cycle- 2 - UPSC MCQ

Neither statement is entirely correct.

The real interest rate can be higher or lower than the nominal interest rate, depending on the inflation rate. The real interest rate is the nominal interest rate adjusted for inflation, so if the inflation rate is higher than the nominal interest rate, then the real interest rate is negative. However, if the inflation rate is lower than the nominal interest rate, then the real interest rate is positive and can be higher than the nominal interest rate.

To neutralize the effects of inflation premium, the lender may increase the nominal rate of interest, not decrease it. The inflation premium is the amount of compensation that lenders require to protect themselves against the erosion of purchasing power caused by inflation. Lenders will typically increase the nominal interest rate to account for the inflation premium, not decrease it.

Therefore, neither statement is entirely correct.

• It is a graphic curve which advocates a relationship between inflation and unemployment in an economy.

• As per the curve, there is a 'trade-off between inflation and unemployment, i.e., an inverse relationship between them.

• The curve suggests that lower the inflation, higher the unemployment and higher the inflation, lower the unemployment.

• The NAIRU is that rate of unemployment which is consistent with a constant rate of inflation. It means at NAIRU, the upward and downward forces on price (inflation) and wage (unemployment) neutralise each other and there is no tendency of change in the rate of inflation.

• We may say that the NAIRU is the lowest unemployment rate that an economy can sustain without any upward pressure on the inflation rate.

Hyperinflation is ‘large and accelerating’ which might have the annual rates in million or even trillion. In such inflation not only range of increase is very large but the increase takes place in a very short span of time, prices shoot up overnight. 
Creeping inflation is slow and unpredictable 11 lines which might be called small or gradual. This is a comparative term which puts it opposite to the faster, bigger and unpredictable inflations. Low inflation takes place in a longer period and the range of increase is usually in ‘single digit’. 
We may take an example of the monthly inflation rate of a country for six months being 2.3%, 2.6%, 2.7%, 2.9%, 3.1% and 3.4%. Here the range of change is of 1.1% and over a period of six months.

Both statements are correct.

1. When inflation occurs, the prices of goods and services increase, and people need to spend more money to buy the same quantity of goods and services as before. This means that the purchasing power of their income decreases, which ultimately leads to a decrease in consumption levels.

2. Inflation also increases the cost of borrowing money, which means that the interest rates on loans increase. As a result, people and businesses tend to decrease their investment expenditure as the cost of borrowing money becomes too high.

Therefore, both statements correctly describe the effects of inflation on expenditure.

• The extent to which tax collections of the government are concerned, inflation increases the nominal value of the gross tax revenue, while the real value of the tax collection does not compare with the current pace of inflation as there is a lag (delay) in the tax collection in all economies.

• But governments get an advantage on their interest burden, on their borrowings as inflation benefits borrowers. This benefit, however, depends upon the contemporary levels of fiscal deficit and the total national debt.

• India's official Housing Price Index (HPI) was launched in July 2007 in Mumbai.

• Developed by the Indian home loans regulator, the National Housing Bank (NHB) the index is named NHB Residex.

• Presently, the index has been introduced as a pilot project for five cities Bangalore, Bhopal, Delhi, Kolkata and Mumbai, -till now it has been updated up to the quarter ended March 2016.

The business cycle of recovery may show the following economy traits:

• (i) an upturn in aggregate (total) demand which has to be accompanied by an increase in the level of production;

• (ii) production process expands and new investments become attractive;

• (iii) as demand goes upward, inflation also moves upward making borrowing cheaper for investors;

• (iv) with an upturn in production, new employment avenues are created and the unemployment rate starts declining, etc.

The major traits of depression could be as given below.

• (i) an extremely low aggregate demand in the economy causes activities to decelerate;

• (ii) the inflation being comparatively lower;

• (iii) the employment avenues start shrinking forcing unemployment rate to grow fast;

• (iv) to keep the business going, production houses go for forced labour-cuts or retrenchment (to cut down production cost and be competitive in the market,) etc.