The Hindu Editorial Analysis- 10th September, 2022 | Current Affairs & Hindu Analysis: Daily, Weekly & Monthly - UPSC PDF Download

Staying the Course

Why in News?

• Over a period of time, Inflation may have moderated a bit, but remains a threat that warrants constant vigil.
• The Finance Ministry expects inflationary pressures to be ‘capped’ due to steps taken by the central bank and the Government

What is inflation?

• Inflation is the rate at which the price of goods and services in a given economy rises.
• Inflation occurs when prices rise as manufacturing expenses, such as raw materials and wages, rise.
• Inflation can result from an increase in demand for products and services, as people are ready to pay more for them.
• Let us consider we can buy 1 litre of milk for Rs. 50 at the current time. Exactly 1 year before 1 litre of milk cost us Rs. 40.
• Here there is an increase of Rs. 10 per litre of milk or the purchasing power of Rs.40 has reduced from buying 1 litre of milk to 800ml of milk in 1 year.

There are two types of inflation –

• Demand Pull Inflation: Demand pull inflation arises when aggregate demand in the economy becomes more than aggregate supply.
• Cost push inflation: when there is decrease in aggregate supply of goods and services results into increase in cost of production.

Causes of Inflation

• Demand Side inflation is caused by high demand and low production or supply of multiple commodities create a demand-supply gap, which leads to a hike in prices due to increase in consumption; Also, Increase in exports which undervalues rupee; Also, the excess circulation of money leads to inflation as money loses its purchasing power With people having more money, they also tend to spend more, which causes increased demand.
• Cost Pull inflation is caused by shortage of factors of production like labour, land, capital etc. and also due to artificial scarcity created due to hoarding. For example, Brent crude prices crossed $65 per barrel in May 2021, more than double of what it was a year ago. Price of vegetable oils, a major import item, shot up 57% to reach a decadal high in April 2021. Metals prices are near the highest in 10 years and international freight costs are escalating.

Effect of Inflation 

• The purchasing power of a currency unit decreases as the commodities and services get dearer.
• This also impacts the cost of living in a country. When inflation is high, the cost of living gets higher as well, which ultimately leads to a deceleration in economic growth.
• A certain level of inflation is required in the economy to ensure that expenditure is promoted and hoarding money through savings is demotivated.

Pros and Cons of Inflation targeting in India

• Inflation targeting is a monetary policy in which a central bank has an explicit target inflation rate for the medium term and announces this inflation target to the public. It will have price stability as the main goal of monetary policy.
• Many central banks adopted inflation targeting as a pragmatic response to the failure of other monetary policy regimes, such as those that targeted the money supply or the value of the currency in relation to another, presumably stable, currency.

Pros:

• It will lead to increased transparency and accountability.
• Policy will be linked to medium/long term goals, but with some short term flexibility.
• With inflation targeting in place, people will tend to have low inflation expectations. If there was no inflation target, people could have higher inflation expectations, encouraging workers to demand higher wages and firms to put up prices.
• It also helps in avoiding boom and bust cycles.
• If inflation creeps up, then it can cause various economic costs such as uncertainty leading to lower investment, loss of international competitiveness and reduced value of savings. This can also be avoided with targeting.
• Inflation targets can have various benefits, especially during ‘normal’ economic circumstances. However, the prolonged recession since the credit crunch of 2008 has severely tested the usefulness of inflation targets

Cons:

• It puts too much weight on inflation relative to other goals. Central Banks Start to Ignore More Pressing Problems like unemployment.
• Inflation target reduces “flexibility”. It has the potential to constrain policy in some circumstances in which it would not be desirable to do so.
• Cost-push inflation may cause a temporary blip in inflation.
• It cannot help remove supply bottlenecks and shortages
• It cannot help external shocks, exchange rate might suffer in the short run
• Growth and employment might take hits in the short run

Measures to control Inflation

• Inflation can be majorly caused due to two reasons. One is the Demand-Pull inflation and the other is the cost-push inflation on the supply side.
• In the case of demand-pull inflation all the control measures revolve around reducing the demand, this can be done by either reducing the money supply or increasing prices by taxation.
• In the case of cost-push inflation, the control measures revolve around increasing the supply to meet the demand in the market and reduce the prices by providing subsidies and technological expertise.
• In all cases, the inflation control measulres can be divided into Monetary Measures, Fiscal Measures and Administrative Measures.