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SUBMITTED TO IAEERS PUNE INSTITUTE OF BUSINESS MANAGEMENT (APPROVED BY AICTE, MINISTRY OF HRD, GOVT. OF INDIA) PUNE 2011-2013
ACKNOWLEDGEMENT
This report has been an honest and dedicated attempt to make the analysis on marketing material as authentic as it could. And I earnestly hope that it provides useful and workable information and knowledge to any person reading it. I express my sincere thank to my thesis report guide and my institute faculties for guiding me. Lastly I am grateful to my parents who been my mentor and motivation I am also thankful to all my batch mates who have been directly or indirectly involved in successful completion of this thesis report.
TABLE OF CONTENT
Chapter no. Topic Introduction Background of the study Statement of the Problem Objectives of the Study Hypotheses of the Study Significance of the Study Scope and Limitations of the Study Definition of Terms Review of Related Literature Features of Inflation Types of Inflation Some advantages of planned inflation? Causes of Inflation Measurement of Inflation in India Economic Effects of Inflation How to control Inflation? Why is RBI unable to control inflation? The Relationship between Interest and Inflation What Is the Relationship between GDP and Inflation? Page no 4 5 6 7 7 7 8 8 9-13 14-15 16-19 20 21-24 25-27 28-29 30-32 33 34 35
2 3
4 5 6
Methodology
Research Report Survey on Inflation in India Summery Conclusion Recommendations Bibliography Appendix : Inflation rate, GDP Rate, Repo Rate, Reverse Repo Rate, CRR Rate and SLR Rate in India
CHAPTER- 1.
Introduction
Inflation means a considerable and persistent rise in the general price of goods and services over a period of time. It indicates the percentage rise in the general prices today compare to a year ago. The rise (fall) in inflation means that purchasing power of money declines (increases). A continuous rise in the general price level over a long period of time has been the most common feature of both developed and developing economies. India, a fast developing nation is facing a high rate of inflation which has created economic, social, and political problems of the country. It is the stage of too much money chasing too few goods. It is perhaps the second most serious macroeconomic problem confronting the world economy today. This problem has claimed more attention of the economists, policy makers and politicians. The prices of commodities will, over time, rise and fall, responding to the pulls and pushes of demand and supply. These price movements are natures way of signaling to consumers that they should consume less of the commodity facing shortage and more of the commodity in glut and to producers to produce more of what is in short supply and less of what is available in plenty. For the common person, there is something threatening about the phenomenon of inflation, especially on those occasions when the rise in prices of goods is not matched by an equivalent increase in the prices of labour. Consequently, inflation also reflects erosion in the purchasing power of money- a loss of real value in the internal medium of exchange and unit of account in the economy. The effects of inflation are not distributed evenly in the economy, and as a consequence there are hidden costs to some and benefits to others from this decrease in the purchasing power of money. (Later termed monetary inflation) has on the price of goods (later termed price inflation, and eventually just inflation).
Definition of Terms
Deflation: Deflation is a condition of falling prices. It is just the opposite of inflation. In deflation, the
value of money goes up and prices fall down. Deflation brings a depression phase of business in the economy.
Disinflation: Disinflation refers to lowering of prices through anti-inflationary measures without causing
unemployment and reduction in output.
Reflation: Reflation is a situation of rising prices intentionally adopted to ease the depression phase of the
economy. In reflation, along with rising prices, the employment, output and income also increase until the economy reaches the stage of full employment.
Stagflation: Paul Samuelson describes Stagflation as the paradox of rising prices with increasing rate of
unemployment.
Stagnation: Stagnation in the rate of economic growth which may be a slow or no economic growth at all. Statflation: The term 'Statflation' was coined by Dr. P.R. Brahmananda to describe the inflationary
situation of India. According to Brahmananda, Rising prices in the middle of a recession is known as Statflation
CHAPTER 2.
REVIEW OF RELATED LITERATURE Topic: Evaluating Core Inflation Measures for India Author: Motilal Bicchal, Naresh Kumar Sharma and Bandi Kamaiah Abstract:This paper discusses in some detail various existing approaches of measuring core
inflation, evaluating their potential advantages and disadvantages. Then a variety of measures of core inflation for India based on three methods are constructed. Among these measures, three are based on conventional exfood and energy principle and one measure that exclude fifteen of most volatile components are constructed. While constructing exclusion based indices of core inflation; measures are constructed such that only a small weight remains excluded from the index of the core inflation. The other two core measures are variations of Neo Edgeworthian Index are constructed by reweighting 69 disaggregated components series of WPI. Then another class of core measures is computed based on weighted exponential smoothing which was primarily developed by Cogley (2002). Estimates of core inflation based on their indices are then calculated for 1995 to 2007 (on monthly basis).
Conclusion: Since the inception of the term core inflation, there is neither a commonly accepted heretical
definition nor an agreed method of measuring it. Because of the fact that it isunobservable, it has to be estimated. One of the objectives of this paper was to review existing theoretical approaches of measuring core inflation. We, then, constructed several measures of core inflation for India. Among these measures, three are based on popular ad hoc exclusion principle and one measure that exclude fifteen of most volatile components. While constructing exclusion based core indices, we determined that it should be done such that small amount of weight is excluded in constructing the core index. The other two core measures, which are variations of Neo-Edgeworthian Index, were constructed by reweighting 69 disaggregated components series of WPI. Further, another class of core measures was constructed based on weighted exponential smoothing which was primarily developed by Cogley (2002).
Topic: Inflation Targeting in India: Issues and Prospects Author: Raghbendra Jha Abstract: Inflation targeting (henceforth IT) has emerged as a significant monetary policyframework in
both developed and transition economies. Some authors have argued that for transition economies undergoing sustained financial liberalization and integration in world financial markets IT is an attractive monetary policy framework. The present paper evaluates the case for IT in India. It begins by stating the objectives of monetary policy in India and argues that inflation control cannot be an exclusive concern of monetary policy with widespread poverty still present. The rationale for IT is then spelt out and found to be incomplete. The paper provides some evidence on the effects of IT in developed and transition economies and argues that although IT may have been responsible for maintaining a low inflation regime it
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has not brought down the inflation rate itself substantially. Further, the volatility of exchange rate and output movements in transition rise adopting IT has been higher than in developed market economies. I then discuss Indias experience with using rules-based policy measures (nominal targets) and discuss why India is not ready for IT. I show that even if the Reserve Bank of India (RBI) wanted to, it could not pursue IT since the short-term interest rate (the principal policy tool used to affect inflation in rise working with IT) does not have significant effects on the rate of inflation. The paper concludes by listing monetary policy options for India at the current time.
Conclusion: This paper has argued that the primary objective of Indian monetary policy, at least in the
medium term, has to be the attainment of higher economic growth. Moreover, since India has high inflation aversion, this objective does not conflict with that of short termstabilization.Monetary policy in India has to be conducted against this background. This paper has argued that the multi-objective formulation pursued by the RBI has merit and that such monetary policy should be pursued to maintain stable interest and inflation rates and as lightly undervalued currency in order to engineer higher export led growth. A second policy measure is weighted towards real exchange rate appreciation (more in line with IT) and would involve relatively larger current ac deficits. Real appreciation, intern, could be secured by nominal appreciation or by permitting higher inflation. Both policies would lead to low inflation rates and reduced inflows of foreign capital and, therefore, lower accumulation of reserves at given rates of sterilization. Policy packages that use import liberalization would, like real appreciation, permit higher absorption via higher current ac deficits but without penalizing exports. The optimal package for India is a judicious combination of these two broad sets of policies with greater emphasis on fiscal consolidation and import liberalization, rather than real exchange rate appreciation via nominal appreciation or inflation. These are essential elements of an appropriate monetary policy regime for India.
Topic: Inflation Determination with Taylor Rules: A Critical Review Author: John H. Cochrane Abstract: The new-Keynesian, Taylor-rule theory of inflation determination relies on explosive dynamics.
By raising interest rates in response to inflation, the Fed does not directly stabilize future inflation. Rather, the Fed threatens hyperinflation or deflation, unless inflation jumps to one particular value on each date. However, there is nothing in economics to rule out hyperinflationary or deflationary solutions. Therefore, inflation is just as indeterminate under active interest rate targets as it is under standard fixed interest rate targets. Inflation determination requires ingredients beyond an interest-rate policy that follows the Taylor principle.
Conclusion: Practically all verbal explanations for the wisdom of the Taylor principle the Fed should
increase interest rates more than one for one with inflation use old-Keynesian, stabilizing, logic: This action will raise real interest rates, which will dampen demand, which will lower future inflation. NewKeynesian models operate in an entirely different manner: by raising interest rates in response to inflation, the Fed threatens hyperinflation or deflation, or at a minimum a large non-local movement, unless inflation jumps tone particular value.
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Topic: inflation theory: a critical Literature review and a new Research agenda Author: Alfredo Saad-Filho Abstract:Marxian analyses of inflation tend to fall under three broad categories, those thatemphasize
primarily the role distributive conflicts, monopoly power, or state intervention on the dynamics of credit money. This article reviews these interpretations, and indicate show they can be integrated. The proposed approach, based on the 'extra money' view, departs from the circuit of capital and the endogeneity of credit money in order to explain inflation in inconvertible paper money systems.
Conclusion: This article has analyzed critically the three best known Marxian theories of inflation. They
argue, in different ways, that inflation is a historically specific phenomenon, but its form can be abstractly determined from the broad features of modem capitalism. However, beyond a certain point concrete studies become necessary in order to contextualize the analysis. Different alternatives are proposed in order to overcome the difficult dilemmas imposed by the attempt to explain inflation in inconvertible money systems, while preserving the endogeneity and non-neutrality of money. They are also heavily dependent on the context of the analysis.
Topic: exchange rate regimes and inflation Only hard pegs make a difference Author: Michael Bleaney and Manuela Francisco Abstract: Previous research has suggested that pegged exchange rates are associated with lower inflation
than floating rates. In which direction does the causality run? Using data from a large sample of developing rise from 1984 to 2000, we confirm that hard pegs (currency boards or a shared currency) reduce inflation and money growth. There is no evidence that soft pegs confer any monetary discipline. The choice between soft pegs and floats is determined by inflation: when inflation is low, pegs tend to be chosen and sustained, and when inflation is high, either floats are chosen or there are frequent regime switches.
Conclusion: The theoretical analysis suggested that pegs would be associated with lower inflation than
floats, provided that the costs of devaluation were significant. Whether the costs of devaluation represent a major deterrent to inflation in any given form of peg is an empirical question. In our empirical work we distinguish hard pegs (a shared currency or a currency board) from other forms of peg (soft pegs), on the grounds that the obstacles or disincentives to devaluation are much higher for hard pegs.
Topic: Inflation and Growth: In Search of a Stable Relationship Author: Michael Bruno and William Easterly
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Abstract: Are inflation and growth inversely associated, directly associated, or not associated? Is the
empirical inflation growth relationship primarily a long-run relationship across rise, a short run relationship across time, or both? Like a bickering couple, inflation and growth just cannot seem to decide what their relationship should be.
Conclusion: The early empirical literature on inflation and growth found little in the way of relationship
between the two. The growth literature detected a relationship between inflation and growth only after rise kindly provided some discrete high inflation crises in the 1980s. And even then it was still unclear whether there was a long-run or a short-run relationship because the empirical relationships were weak with longperiod averages and strong with short-period averages. Despite extensive counseling by the new growth literature, the indecisive couple of inflation and growth cannot decide whether they belong together in the short run or in the long run.
advanced countries) above which inflation quickly becomes harmful to growth. However, for the advanced economies, threshold was much lower. Many studies in Indian context have provided differing views on inflation threshold. Chakarvarty Committee (1985) referred to it as the acceptable rise in prices at 4 per cent. This, according to the Committee, reflects changes in relative prices necessary to attract resources to growth sectors. As growt h is not uniform in all the sectors, maintaining absolute price stability, meaning a zero rate of increase in prices, may not be possible and nor is it desirable. Rangarajan (1998), who pioneered the concept of threshold inflation, brought central bank focus on inflation rate at 67 per cent known as acceptable level of inflation. His idea of threshold was: at what level of inflation do adverse consequences set in? The study by Vasudevan et al. (1998) and, Kannan and Joshi (1998) found the threshold level to be around 6 per cent. Results of Samantaraya and Prasad (2001) are also on similar line as they found the threshold level to be around 6.5 per cent. In contrast, Singh and Kalirajan (2003) using annual data for the period of 1971 1998 provided argument against any threshold level for India. A more recent study by Singh (2010) which used both, yearly and quarterly data, found threshold level of inflation for India at 6 per cent but failed to confirm the same in Sarel (1996) sense.
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CHAPTER 3.
THEORETICAL/CONCEPTUAL/OPERATIONAL FRAMEWORK
FEATURES OF INFLATION:
Following are the main features of inflation: 1. The phenomenon is not to be equated with the fact of high prices. It is a phenomenon of rising prices. It is a continuous fall in the purchasing power of money in absolute terms. 2. In an economy which uses money and credit and which operates under the guidance of market mechanism, some adjustment of individual prices is always going on in response to the dynamism of changing demand and supply forces. In other words, in such an economy, a continuous shift is taking place in relative prices. However, inflationary process is not the adjustment of individual prices, or relative prices. It is a process of continuous price rise in absolute terms, that is, a process of continuous fall in the purchasing power of money. The phenomenon of price rise is not restricted to only selected items. Its coverage keeps increasing and more and more prices start rising. 3. There is no absolute rate of price rise, which can be said to demarcate between inflationary and noninflationary situations. This is because, by its very nature, an inflationary process is a continuous and cumulative one. Having started once, the rate of price rise keeps gathering momentum and is bound to exceed any prescribed rate. Unless we are able to check it through some means, the rate of price rise becomes so high that it leads to the collapse of the entire monetary system of the country. 4. As we have noted before, in a market economy, several individual prices are always under a process of adjustment in response to forces of demand and supply forces. In addition, there is a close input-output relationship between different categories of economic activities. In other words, when one price changes, there is generally an increase in input cost of several other economic activities which in turn leads to further price rise. The result is that it is possible for any individual price rise to become a cause for an inflationary process. We cannot keep an eye on only some selected prices and be sure that inflationary process would not start. 5. On account of input-output relations between different industries, inflationary process keeps increasing its coverage. With the passage of time, more and more prices are engulfed by it. It also leads to an increasing rate of price rise. It becomes a self-feeding cumulative process. 6. On account of close interaction between industries, we do not have any predetermined set of causes and 'effects' of inflation. A given macro-variable alternatively becomes its cause and effect. For example, an increase in wage rate can result in an increase in production costs. Higher production costs can become the cause of higher prices, which in turn can become the cause of further rise in wages. 7. Higher prices necessitate a greater need for means of payment in the form of currency and credit. The authorities also require more funds to finance their activities. As a result, they increase the supply of currency. And at the same time, there is a greater generation of credit in the economy. However, increasing supply of money and credit helps in pushing prices further up, leading to the need for still additional supply
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of money and credit. Thus, a continuous increase in the supply of money and credit becomes an essential feature of inflation. 8. When inflationary process gains strength, it gives rise to expectations of further price rise. This increases the speed with which people spend their money balances. 9. When expectations of price rise become widespread, the suppliers develops tendency to hold back supplies, pile up stocks and create an artificial scarcity. They find that to hold back existing supplies is becoming increasingly more profitable than to produce fresh. 10. Price expectations also alter the asset preferences of the community. People prefer to hold more of nonmonetary assets, which are expected to retain their 'real' purchasing power as against nominal money balances, which are continuously losing their purchasing power. 11. In the initial stages, there is an increase in interest rate because the lenders want to be compensated for the loss in the purchasing power of their loans. In later stages, however, money starts losing value so fast that the entire financial system may be disrupted and eventually collapses. 12. In the initial stages of inflation, the economy registers a growth in the output and employment along with an increase in prices. That is to say, rising prices provide an incentive to investors and producers in the form of higher expected profit. They are ready to invest more even in the face of rising rate of interest. However, in later stages of inflation. (i) The phenomenon of increasing costs (ii) Expectations of further rice rise (iii) Other factors lead to a fall in real output and prices while there is an exponential growth in the supply of money. 13. Right from the beginning, there is a growing inequality in income distribution. Contractual incomes {like wages, interest, rent, etc.) lag behind while non- contractual and for residual incomes (like profit) increase in both absolute terms and as a proportion of the national income. 14. Inflation is the result of market imperfections. If the demand and supply flows are able to adjust themselves to changing prices without time lags, a persistent price rise cannot take place and inflationary process cannot come into existence.
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Types of Inflation
1. Types of inflation on the basis of coverage and scope point of view:Comprehensive Inflation: When the prices of all commodities rise throughout the economy it is known as Comprehensive Inflation. Another name for comprehensive inflation is Economy Wide Inflation. Sporadic Inflation: When prices of only few commodities in few regions (areas) rise, it is known as Sporadic Inflation. It is sectional in nature. For example, rise in food prices due to bad monsoon (winds bringing seasonal rains in India).
War-Time Inflation: Inflation that takes place during the period of a war-like situation is known as WarTime inflation. During a war, scare productive resources are all diverted and prioritized to produce military goods and equipments. This overall result in very limited supply or extreme shortage (low availability) of resources (raw materials) to produce essential commodities. Production and supply of basic goods slow down and can no longer meet the soaring demand from people. Consequently, prices of essential goods keep on rising in the market resulting in War-Time Inflation.
Post-War Inflation: Inflation that takes place soon after a war is known as Post-War Inflation. After the
war, government controls are relaxed, resulting in a faster hike in prices than what experienced during the war.
Peace-Time Inflation: When prices rise during a normal period of peace, it is known as Peace-Time
Inflation. It is due to huge government expenditure or spending on capital projects of a long gestation (development) period.
3. Types of Inflation on Government Reaction Open Inflation: When government does not attempt to restrict inflation, it is known as Open Inflation. In a
free market economy, where prices are allowed to take its own course, open inflation occurs.
Suppressed Inflation: When government prevents price rise through price controls, rationing, etc., it is
known as Suppressed Inflation. It is also referred as Repressed Inflation. However, when government controls are removed, Suppressed inflation becomes Open Inflation. Suppressed Inflation leads to corruption, black marketing, artificial scarcity, etc.
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4. Types of Inflation on Rising Prices Creeping Inflation: When prices are gently rising, it is referred as Creeping Inflation. It is the mildest
form of inflation and also known as a Mild Inflation or Low Inflation. According to R.P. Kent, when prices rise by not more than (up to) 3% per annum (year), it is called Creeping Inflation.
Chronic Inflation: If creeping inflation persist (continues to increase) for a longer period of time then it is
often called as Chronic or Secular Inflation. Chronic Creeping Inflation can be either Continuous (which remains consistent without any downward movement) or Intermittent (which occurs at regular intervals). It is called chronic because if an inflation rate continues to grow for a longer period without any downturn, then it possibly leads to Hyperinflation.
Walking Inflation: When the rate of rising prices is more than the Creeping Inflation, it is known as
Walking Inflation. When prices rise by more than 3% but less than 10% per annum (i.e. between 3% and 10% per annum), it is called as Walking Inflation. According to some economists, walking inflation must be taken seriously as it gives a cautionary signal for the occurrence of running inflation. Furthermore, if walking inflation is not checked in due time it can eventually result in Galloping inflation.
Moderate Inflation: Prof. Samuelson clubbed together concept of Crepping and Walking inflation into
Moderate Inflation. When prices rise by less than 10% per annum (single digit inflation rate), it is known as Moderate Inflation. According to Prof. Samuelson, it is a stable inflation and not a serious economic problem.
Running Inflation: A rapid acceleration in the rate of rising prices is referred as Running Inflation. When
prices rise by more than 10% per annum, running inflation occurs. Though economists have not suggested a fixed range for measuring running inflation, we may consider price rise between 10% to 20% per annum (double digit inflation rate) as a running inflation.
Galloping Inflation: According to Prof. Samuelson, if prices rise by double or triple digit inflation rates
like 30% or 400% or 999% per annum, then the situation can be termed as Galloping Inflation. When prices rise by more than 20% but less than 1000% per annum (i.e. between 20% to 1000% per annum), galloping inflation occurs. It is also referred as jumping inflation. India has been witnessing galloping inflation since the second five year plan period.
Hyperinflation: Hyperinflation refers to a situation where the prices rise at an alarming high rate. The
prices rise so fast that it becomes very difficult to measure its magnitude. However, in quantitative terms, when prices rise above 1000% per annum (quadruple or four digit inflation rate), it is termed as Hyperinflation. During a worst case scenario of hyperinflation, value of national currency (money) of an affected country reduces almost to zero. Paper money becomes worthless and people start trading either in gold and silver or sometimes even use the old barter system of commerce. Two worst examples of hyperinflation recorded in world history are of those experienced by Hungary in year 1946 and Zimbabwe during 2004-2009 under Robert Mugabe's regime.
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Oil prices in the international market suddenly increases to $150 per barrel. Now India to continue its oil imports from Iran has to pay $50 more per barrel to get the same amount of crude oil. When the imported expensive oil reaches India, the Indian consumers also have to pay more and bear the economic burden. Manufacturing and transportation costs also increase due to hike in oil prices. This, consequently, results in a rise in the prices of domestic goods being manufactured and transported. It is the end-consumer in India, who finally pays and experiences the ultimate pinch of Import Price-Hike Inflation. If the oil prices in the international market fall down then the import price-hike inflation also slows down, and vice-versa. Sectoral Inflation: It occurs when there is a rise in the prices of goods and services produced by certain sector of the industries. For instance, if prices of crude oil increase then it will also affect all other sectors (like aviation, road transportation, etc.) which are directly related to the oil industry. For e.g. If oil prices are hiked, air ticket fares and road transportation cost will increase. Demand-Pull Inflation : Inflation which arises due to various factors like rising income, exploding population, etc., leads to aggregate demand and exceeds aggregate supply, and tends to raise prices of goods and services. This is known as Demand-Pull or Excess Demand Inflation.
Cost-Push Inflation: When prices rise due to growing cost of production of goods and services, it is known as Cost-Push (Supply-side) Inflation. For e.g. If wages of workers are raised then the unit cost of production also increases. As a result, the prices of end-products or end-services being produced and supplied are consequently hiked.
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Causes of Inflation
An increase in the general level of prices implies a decrease in the purchasing power of the currency. This problem is not too serious. What matters is not how fast and how long the price level must rise before the rise is called inflationary but what causes the price level to rise in the first place and what are the consequences of different rates of price level change for the distribution of income
High Demand: If the demand for a commodity is much above than the supply, the price of the
commodity would increase. It is so happened in 2010 that a decrease in sugarcane production led to decreased production of refined sugar causing its prices to rise in the open market. This kind of inflation is called demand pull inflation.
Supply led Inflation: The recent rise in rubber, iron, and steel prices have led to an increase in the
production cost of automobiles with the consequence that their prices have been hiked by the manufactures. The inflation caused by such a price is called cost push inflation.
Black Marketing: When a particular type of commodity has stocked by a wholesaler and sell in the time
of scarcity of the commodity then it increase the price not only of that commodity but also those which manufactured by the stocked commodity. For example if sugar is stocked by the wholesalers this create the scarcity of the sugar in the market and when demand of sugar reach on peak then it releases on the high prices, the prices of sweets will also go high.
Increase in Purchasing Capacity of Consumer: If some where a retailer increased the price of
commodity for its own profit and more than 50% consumers of the city do not object of this means the 50% consumers have the capacity to purchase that commodity and this will led the inflation.
Interest Rate on Loan given to the Manufacturer by the Banks: When the rate of interest is
increased on the corporate loan the input cost of the manufactured commodity will increased so the cost of finished goods in the market will increased.
Interest Rate on Saving: When the interest rate on savings decreases the common man do not want to
put their money into the banks and so the money will automatically flow towards the market and this will contribute to the inflation.
International fuel Prices: The country like India is highly dependent on the import of crude oil. It
imports more than 70% crude oil from the countries like Iran, and other Arab countries. This crude oil is refined and then converted into petroleum products like petrol, diesel, cooking gas, CNG, kerosene oil, and many more. These fuels are running our houses as well as our transportation system. So, if the price of crude oil fluctuates in international market then in that consequence the prices of all commodities will get affected.
Foreign Exchange Rate: Recently the value of Rupee has depreciated against US Dollar. This
fluctuation in the price of rupee against dollar contributes highly to inflation. We are not independent of the crude oil generation and we purchase the crude oil from other countries. To make this deal we have to pay the dollar for an international deal and to purchase dollar we have pay more amount in Rupees if the price of
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a dollar is high. Interest rate on loan taken from other countries and IMF will become more costly. It simply means the import becomes costly and interest paid on the debt taken contributes to inflation.
Weak INR
Weak Indian Rupee is another cause for inflation here in India. She, imports more than exports, owing to a lot of monetary reasons which also contribute towards a fall in the value of the INR. The national currency plays a vital role in determining the final value of goods and services that have been imported. Since most currencies in the globe are subject to twist, the INR is also not spared. Thus, at the international market, in case the value of INR slides, the final costs would be higher indeed. In India, around 676 commodities are chosen to calculate inflation figures on Thursdays. Since, India is not independent entirely, it has to import some essential commodities to make sure the economic and non economic activities run properly in the economy. Thus, the INR is a key thing which also determines the final prices of goods and services imported. The buying capacity of INR is sliding at the foreign market and thus, the final prices have been increasing which mean inflated goods. The INR has fallen more than a 10% this financial year, 2011, against the greenback. How exactly the fall in the INRs value affects the final prices in India? This can explained with the aid of the following explicit example: Let us assume, the current value of the dollar in terms of the INR is 45. The cost of 1barrel of crude oil is 2 dollars. Then, suppose, India decides to buy 1 barrel of the oil, then India pays 90 rupees. Assume on the next day, the INR falls by a 15% due to some economic reasons (embodying other sorts of reasons), under such an economic state, 1 dollars value in the INR would stand at 51.75 which mean more rupees to be spent to buy the same amount of oil. Thus, the final price of 1 barrel of oil imported would be at 103.50 rupees. This, this hike adds up the final general level of prices leading to inflation.
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Causes for fall in the INR value are as under: 1. Investors pull out their investments from the economy to invest in other economies due to economic and non-economic reasons. By such economic activity of investors, it leads to a fall in the demand for INR, which ultimately results in the fall of the INRs value, too. 2. Political disturbances in the country also reduce the demand for the INR. 3. Other economic issues such as a high rate of inflation also bring down the value of the INR. 4. Stability and insurance of returns on investments assured in other parts of the global economy. 5. Deliberate depreciation by the central bank, etc.
ECONOMIC SECTORS
CONTRIBUTION TO GDP
Primary sector
33%
Secondary sector
30%
Tertiary sector
37%
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Under the above situation, there is still a scope for inflation in the Indian economy since the Indian economy is reliant on foreign trade to meet some of the basic goods and services which mean a fall in the INR value would lead to rise in the value of foreign goods prices making them as inflated goods. But the truth is the above table is awfully close to an unrealistic situation as such types of contributions are not doable, in reality. When we take into account the sectoral contributions, we find out that agriculture sectors share in the GDP is less than 18% in the previous fiscal year (2009-2010). Although, the Indian economy is able to augment its GDP, it does not mean all the basic goods such as oil, vegetables, etc are produced in the economy, which is just one of the things to be done, meaning in case enough such products are made, other factors such transportation costs, infrastructure, natural calamities, etc also play a key role in determining their prices before they are sold in markets. Thus, we learn from this article that, India in order to meet its basic requirements, it buys some basic goods which is a result of an increase in buying capacity of the economy due to the augmentation in the GDP value, from overseas at inflated prices, sometimes, and as the INRs value is subject to change, inflated products are also bought in to the economy for meeting endogenous demand. Hence proved, economic growth would lead to inflation in any economy.
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measure of the Inflation rate, particularly from the managerial point of view. As the data is available for different commodity groups, policy makers can easily pin down the source of inflation and then suggest the policy measures to deal with it. It excludes the prices of all services, such as health, education, banking, transport and communication. The Indian Government has taken WPI as an indicator of the rate of inflation in the economy. 3) Consumer Price Index: The CPI measures price change from the perspective of the retail buyer. It is the real index for the common people. It reflects the actual inflation that is borne by the individual. CPI is designed to measure changes over time in the level of retail prices of selected goods and services on which consumers of a defined group spend their incomes Consumer Price Index is measured on the basis of the change in retail prices of a specified set of goods and services on which a particular group of consumers spend their money. It excludes the prices of capital goods, raw materials and intermediate goods. It includes the prices of services as well as of imported goods. The consumption basket depends on the level of income, rural-urban living, and type of profession the family is engaged in, habits and customs and so on. It reflects the cost of living index condition for a homogenous group based on retail price. It actually measures the increase in price that a consumer will ultimately have to pay for. CPI inflation rate = [(CPIt CPIt-1)/CPIt-1]*100 CPIt = CPI of current year, CPIt-1 = CPI of pervious year There are three measures of CPI. Set of goods and services for each CPI measure is different based on the consumption pattern of the particular group:A) CPI for Industrial Workers (CPI-IW): The labour bureau of the Ministry of Labour compiles and publishes data on CPI-IW. It is first prepared at the selected centres levels, and then aggregated to all India level. The CPI-IW is currently available at 2001=100 base. For CPI-IW, a basket of 260 commodities is tracked. It has got a broader coverage of set of goods and services, and that is why CPI-IW is extensively used as cost of living index in organized sector. B) CPI for Urban non-manual Employees (CPI-UNME): CPI-UNME is carried out by Central Statistical Organization. It is first prepared at the selected centres levels, and then aggregated to all India levels. Currently, this index is published with the base 1984-85=100. For CPI-UNME a basket of 180 commodities is tracked. C) CPI for Agricultural laborers (CPI-AL): The Labour bureau of the Ministry of Labour compiles and publishes data on CPI-AL. It is first prepared at the state level and then aggregated to all India levels. CPIAL series is currently published for the base 1986-87=100. For CPI-AL a basket of 60 commodities is tracked. The CPI-AL would give a greater weighted to food grain.
PPI due to the broader coverage provided by the PPI in terms of products and industries and the conceptual concordance between PPI and system the national account. PPI is considered to be more relevant and technically superior compared to one at wholesale level. However, in India we are still continuing with WPI.
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of inflation. So, the labour in this sector is a net loser during the period of inflation. The organized labour uses its union power to get compensatory increase in their wages. The labour in this sector is adequately compensated for the loss of purchasing power due to inflation. So the wage earners in this sector have gained during the period of inflation. B) Producers: Producers gain or loss due to inflation depends on the rates of increase in prices they receive and the prices they pay. Product prices rise first and faster than the cost of production. These prices rise first due to demand pull factors such as rise in money supply, rise in income, increase in investment, increase in export etc. The input prices remaining the same, profit margin increases. This creates additional demand for inputs pushing the input prices up, though at different rates and with different time lags. Other input prices increase at a lower rate. So producers are the net gainers due to wage-lags during the period of inflation. However, firms have to bear some additional cost during the period of inflation, especially when inflation rate keeps increasing; firms are required to receive their prices, print new price lists and publicize their new prices. The cost incurred for this purpose is called menu cost and in spite of these costs, the firms stand to gain from inflation. C) Fixed Income Class: The income of the fixed income class people remains constant during the period of inflation but the prices of goods and services they consume increases. As a result, the purchasing power of their income gets eroded in proportion to the rate of inflation and they become net losers during inflation. D) Borrowers and Lenders: Under inflation borrowers gain and lenders lose because when borrower repays to the lender under inflationary situation, then he will be returning less purchasing power to the lender than what he borrowed earlier. 4) Effect of Inflation on Economic Growth: The rate of economic growth depends on the rate of capital formation which depends on the rate of saving and investment. There is a positive relationship between inflation and saving and investment and, therefore, inflation is conducive to economic growth. During the period of inflation, there is a time lag between the rise in output prices and rise in input prices, which is called wage-lag. When the wage-lag persists over a long period of time, it increases the profit margin. The increased profits provide both incentive for a larger investment and also the investible funds to the firms. This results in an increase in production capacity and a higher level of output. Inflation tends to redistribute incomes in favor of higher income groups. This kind of inflation increases total savings because these upper income groups have a higher propensity to save. The increase in saving increases the supply of investible funds and lowers the rate of interest. A lower rate of interest increases investment. With increase in investment, production capacity of the economy increases. This causes an increase in the total output, which means economic growth. 5) Effect of Inflation on Employment: Inflation has promotional effect on employment. Inflation affects growth variables such as savings, investment and profits favorably and to increase in investment rate, the rate of employment will also increase till the economy reaches the full employment level. A.W.Phillips, a British economist found an inverse relationship between the rate of changes in the money wage rate and the rate of unemployment. He presented this inverse relationship in the form of a curve, called Phillips curve. According to this, the rise in money wage rate may be the cause or effect
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FISCAL MEASURES
Fiscal policy is another type of budgetary policy in relation to taxation, public borrowing, and public expenditure. To curve the effects of inflation and changes in the total expenditure, fiscal measures would have to be implemented which involves an increase in taxation and decrease in government spending. During inflationary periods the government is supposed to counteract an increase in private spending. It can be cleared noted that during a period of full employment inflation, the aggregate demand in relation to the limited supply of goods and services is reduced to the extent that government expenditures are shortened. Along with public expenditure, governments must simultaneously increase taxes that would effectively reduce private expenditure, in an effect to minimize inflationary pressures. It is known that when more taxes are imposed, the size of the disposable income diminishes, also the magnitude of the inflationary gap in regards to the availability of the supply of goods and services. In some instances, and tax policy has been directed towards restricting demand without restricting level of production. For example, excise duties or sales tax on various commodities may take away the buying power from the consumer goods market without discouraging the level of production. However, some economists point out that this is not a correct way of combating inflation because it may lead to a regressive status within the economy. As a result, this may lead to a further rise in prices of goods and services, and inflation can spread from one sector of the economy to another and from one type of goods and services to another. Therefore, a reduction in public expenditure, and an increase in taxes produces a cash surplus in the budget. Keynes, however, suggested a programme of compulsory savings, such as deferred pay as an anti-inflationary measure. Deferred pay indicates that the consumer defers a part of his or her wages by buying savings bonds (which, of course, is a sort of public borrowing), which are redeemable after a particular period of time, this is sometimes called forced savings. Additionally, private savings have a strong disinflationary effect on the economy and an increase in these is an important measure for controlling inflation. Government policy should therefore, include devices for increasing savings. A strong savings drive reduces the spendable income of the consumers, without any harmful effects of any kind that are associated with higher taxation. Furthermore, the effects of a large deficit budget, which is mainly responsible for inflation, can be partially offset by covering the deficit through public borrowings. It should be noted that it is only government borrowing from non-bank lenders that has a disinflationary effect. In addition, public debt may be managed in such a way that the supply of money in the country may be controlled. The government should avoid paying back any of its past loans during inflationary periods, in order to prevent an increase in the circulation of money. Anti-inflationary debt management also includes cancellation of public debt held by the central bank out of a budgetary surplus. Fiscal policy by itself may not be very effective in combating inflation; therefore a combination of fiscal and monetary tools can work together in achieving the desired outcome.
government may have to enforce rationing, along with price control. The main function of rationing is to divert consumption from those commodities whose supply needs to be restricted for some special reasons; such as, to make the commodity more available to a larger number of households. Therefore, rationing becomes essential when necessities, such asfood grains, are relatively scarce. Rationing has the effect of limiting the variety of quantity of goods available for the good cause of price stability and distributive impartiality. However, according to Keynes, rationing involves a great deal of waste, both of resources and of employment. Another control measure that was suggested is the control of wages as it often becomes necessary in order to stop a wage-price spiral. During galloping inflation, it may be necessary to apply awageprofit freeze. Ceiling s on wages and profits keep down disposable income and, therefore the total effective demand for goods and services. On the other hand, restrictions on imports may also help to increase supplies of essential commodity and ease the inflationary pressure. However, this is possible only to a limited extent, depending upon the balance of payments situation. Similarly, exports may also be reduced in an effort to increase the availability of the domestic supply of essential commodities so that inflation is eased. But a country with a deficit balance of payments cannot dare to cut exports and increase imports, because the remedy will be worse than the disease itself. In overpopulated countries like India, it is also essential to check the growth of the population through an effective family planning programme, because this will help in reducing the increasing pressure on the general demand for goods and services. Again, the supply of real goods should be increased by producing more. Without increasing production, inflation just cannot be controlled. Some economists have even suggested indexing in order tominimise certain ill-effects of inflation. Indexing refers to monetary corrections through periodic adjustments in money incomes of the people and in the values of financial assets such as savings deposits, which are held by them in relation to the degrees of price rise. Basically, if the annual price were to rise to 20%, the money incomes and values of financial assets are enhanced by 20%, under the system of indexing.Indexing also saves the government from public wrath due to severe inflation persisting over a long period. Critics, however, do not favor indexing, as it does not cure inflation but rather it encourages living with inflation. Therefore, it is a highly discretionary method. In general, monetary and fiscal controls may be used to repress excess demand but direct controls can be more useful when they are applied to specific scarcity areas. As a result, anti-inflationary policies should involve varied programmers and cannot exclusively depend on a particular type of measure only.
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CHAPTER 4.
METHODOLOGY
RESEARCH OBJECTIVES
To find out middle class people views about inflation and price rise in the economy. To find out effect of inflation on the family budget of middle class people. To find out the effect of inflation on the different consumption object of middle class income group. To find out people view on steps taken by government to control the inflation.
Sources of Data
Primary Data:
Primary data may be described as those data that have been observed and recorded by the researcher for the first time to their knowledge. We have collected primary data through close ended questionnaire method, filled by consumers and retailers.
Secondary Data:
Secondary data means the data which are readily available from different sources. We have gathered these data from the websites, books and magazines.
Research Instrument:
For our research we have used questionnaire, which is the most, commoninstrument used to collect the primary data. A questionnaire consists of the set of questions presented to the respondents for their answers.
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Reliability:
Analysis Reliability analysis allows you to study the properties of measurement scales and the items that make them up. The Reliability Analysis procedure calculates a number of commonly used measures of scale reliability and also provides information about the relationships between individual items in the scale. Interclass correlation coefficients can be used to compute interpreter reliability estimates.
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CHAPTER- 5
Results and Discussion Research Report
Demographics. Gender: Male respondents: 168, Female Respondents: 32 b. Occupation: - Service: 92, Business: 51, Professionals: 13, Farmers: 44 c. Family Income: - 71000-150000: 78, 151000-300000: 111, more than 300000: 11 d. No. of person in Family Family Members: - 1-2: 8, 3-4: 67, 5-6: 99, More than 6: 26 e. No. of Service person in 2008 and in 2009:
Service person in 2008: - 0-2: 196, More than 2:4 Service Person in 2009: -0-2: 194, More than 2: 6
How inflation affect the consumer? Sex Effect of inflation * Sex Cross tabulation
EFFECTS OF INFLATION
TOTAL
Findings: Here 96 people are strongly agrees that inflation affects to the buying behavior of people out of
total surveyed people among them 81 are male & 15 are female. Out of total surveyed people 89 are agree that inflation affects to the routine life of people among them 75 are male & 14 are female. Out of total surveyed people 4 are disagree. To sump approx. 70% of total people are males and remaining are females.
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Occupation
Effect of inflation * Occupation Cross tabulation
OCCUPATION SERVICE EFFECT OF INFLATION STRONGLY AGREE AGREE NATURAL DISAGREE 36 47 9 0 92 BUSINESS 23 25 1 2 51 PROFESSIONAL 8 5 0 0 13 FARMER 29 12 1 2 44 96 89 11 4 200 TOTAL
TOTAL
Findings:Out of total surveyed persons 96 are strongly agree that includes service people, businessmen, Pr
ofessional & Farmers and in number they are 36, 23, 8 & 29respectively. In the same way persons who are agree are 89 that includes service people, businessmen, Professional & Farmers and in number they are 47, 25, 5 & 12respy. Only few peoples are neutral & disagree among total observed people.
Family income
Effect of inflation * Income Cross tabulation
INCOME EFFECT OF INFLATION STRONGLY AGREE AGREE NATURAL DISAGREE TOTAL 71000150000 41 26 7 4 78 151000300001 48 59 4 0 111 MORE THAN 300000 7 4 0 0 11 TOTAL
96 89 11 4 200
Findings: Out of total people 78 are fall under the income between 71000 to 150000 where as 111 persons
fall under the income between 151000 to 300000 and remaining 11 are from more than 3 laces. In the slab of 71 to 150 thousand 41 are agree 26 are agree 7 are neutral& 4 are disagree. In the slab of 151 to 300 thousand 48 are agree 59 are agree 4 are neutral & no one is disagree. In the slab more than 300 thousand 7 are agree 4 are agreed & no one is from neutral & disagree.
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No of member in family
Effect of inflation * No of person in family Cross tabulation
NO. OF PERSON IN FAMILY 1-2 3-4 5-6 EFFECTS OF INFLATION STRONGLY AGREE AGREE NATURAL DISAGREE 4 2 0 2 8 32 32 3 0 67 43 46 8 2 99 MORE THAN 6 17 9 0 0 26 TOTAL 96 89 11 4 200
TOTAL
Findings: Out of total people 8 are fall under such family that consists less than 2 members where as 67
persons fall under such family that consists family member between 3 to 4 and 993are fall under such family that consists less than 2 member income between 151000 to300000 and remaining 11 are from more than 300000. In the slab of 71 to 150 thousand41 are agree 26 are agree 7 are neutral & 4 are disagree. In the slab of 151 to 300thousand 48 are agree 59 are agree 4 are neutral & no one is disagree. In the slab more than 300 thousand 7 are agree 4 are agreed & no one is from neutral & disagree.
Findings: In above table No of service person in family and effect of inflation on consumption, it is given
that 94 respondents from less than 2 persons earning in family strongly agree that inflation affects their consumption where as 87 people are agree with that. While 4 people are disagree. Where as a family consist of 3 to 4 earning persons believe that inflation doesnt affect very largely to the buying behavior of people.
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EFFECTS OF INFLATION
TOTAL
Findings: In above table No of service person in family and effect of inflation on consumption, it is given
that 94 respondents from less than 2 persons earning in family strongly agree that inflation affects their consumption where as 87 people are agree with that. While 4 people are disagree. Where as a family consist of 3 to 4 earning persons believe that inflation doesnt affect very largely to the buying behavior of people.
Lower industrial growth due to sluggish investments Services sector shown more resilience than farm, industry Current environment difficult, future holds promise Revival of growth in advanced nations remains uncertain
Monetary Policy
Fall in inflation to induce monetary easing by RBI Tight RBI policy lead to sharper than expected slowdown Shift in RBI's policy stance "desirable" Lower interest rates to give fillip to investments RBI should weigh cost of economic slowdown, high CPI inflation Set monetary policy based on behavior of core inflation Monetary policy has limited influence on food prices Need to improve access to credit at lower cost
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CHAPTER - 6
Summary
Inflation in India is at an acceptable level and remains much lower than in many other developing countries. But off late prices of essential commodities such as food grain, edible oil, vegetables etc have risen sharply and in the process driving up the inflation rate. Inflation is defined as a sustained increase in the general level of prices for goods and services. It is measured as an annual percentage increase. As inflation rises, the value of currency goes down. Thus the purchasing power of the currency, i.e. the goods and services that can be bought in a unit of currency, too goes down. Measuring inflation is a difficult task. To do so a number of goods that are representative of the economy are put together into what is referred as a "market basket." The cost of this basket is then compared over time. This results in a price index, which is the cost of the market basket today as a percentage of the cost of that identical basket in the starting year. In India two types of index: Consumer Price Index (CPI) and Wholesale Price Index (WPI) are used to monitor inflation. Off the two, Wholesale Price Index (WPI) is the most widely used price index in India. It is used to measure the change in the average price level of goods traded in wholesale market and is available on a weekly basis with the shortest possible time lag only two weeks. The current rise in inflation has its roots in supply-side factors. There was shortfall in domestic production vis-a-vis domestic demand and hardening of international prices, prices of primary commodities, mainly food items. Wheat, pulses, edible oils, fruits and vegetables, and condiments and spices have been the major contributors to the higher inflation rate of primary articles. The inflation was also accompanied by buoyant growth of money and credit. While the GDP growth zoomed to 9.0 per cent per annum, the broad money grew by more than 20 per cent. Demand for nearly everything from housing to fast moving consumer goods is outpacing supply in part because white-collar salaries are rising faster in India than anywhere else in Asia. One of the daunting tasks before the government is to reconcile the twin needs of facilitating credit for growth on the one hand and containing liquidity to tame inflation on the other.
The rate of growth of money supply is a major determinant of inflation over the long term. * International food prices affect inflation in the short term but not in the long term * GDP growth and inflation are negatively correlated over the longer term. So, there is no evidence that higher rate of GDP growth requires higher inflation. * This paper did not test for the threshold level of inflation. The suggested range of 6.0-8.0 per cent inflation threshold emerging from the Bangladesh Bank research is highly debatable. In India it was found to be between 4.5-5.0 per cent, which appears more reasonable. Whether even lower long-term inflation rate (2.03.0 per cent) is achievable without sacrificing growth is an empirical question that needs further research.
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* Inflation causes exchange rate depreciation rather than the other way round. So, the stability of the nominal exchange rate can be ensured by keeping inflation low. * There is no evidence that high rates of broad money or M2 growth (beyond prudent levels) support higher economic growth or investment. Implications for Policies: There are strong and powerful implications for policies that follow from these empirical results. These can be summarized as follows: * Over the long term sustained reduction in the rate of inflation will require reduction in the rate of growth of money supply. This is consistent with international good practice where monetary policy is the primary instrument of inflation control. * A policy of keeping inflation rate low (4.0-5.0 per cent per year) is also good for supporting higher rates of growth. * A policy of easy money does not support higher investment or growth; instead high rates of monetary growth (beyond a level consistent with real GDP growth and desired inflation rate) feed on inflation and negatively affect growth. * Higher rates of growth will require higher investment. Higher investment depends on factors other than the rate of growth of money supply (beyond prudent levels). * Fiscal policy will need to be consistent with the targets of prudent monetary management. Accommodating sustained international price increases in fuel prices through budgetary subsidies that is financed through borrowing from the Bangladesh Bank is inconsistent with sound monetary management and inflation control. * The causality from inflation to exchange rate is a very powerful and fundamental result for policy making. The main message is that if we want to have a stable exchange rate over the longer term, we need to keep the rate of inflation low and closely aligned to international inflation. * The other policy that could help stabilize the exchange rate is foreign capital inflows. Bangladesh does not have a strategy for mobilizing foreign capital and as such is missing out on one useful policy instrument for exchange rate management.
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Conclusion
Inflation is an intractable problem. Its effects are felt to some degree by every citizen and in every corner of the country. Most economists generally agree that a moderate rate of inflation is conducive to economic growth and that, in the short run, there is positive relationship between moderate rate of inflation and economic growth. A high rate of inflation, especially when it is unanticipated, throws investment and production plans out of gear. When price rise is unpredictable, people find it very difficult to determine the course of their response to the price changes. This upsets the price system which causes inefficient allocation of resources and, thereby, a lower output. This adds inefficiencies in the market and makes it difficult for companies to plan long term. Inflation can act as a drag on productivity as companies are forced to shift resources away from products and services in order to focus on profit and losses from currency inflation. The WPI provides an idea about the average price level of goods traded in wholesale market whereas the CPI measures the final cost paid by consumers. CPI inflation is more important from the point of view of controlling inflation, especially in a country like India, where the existence of the unorganized sector and incidence of poverty is reasonably high. From the conduct of monetary policy point of view, right tracking of inflation for the country as a whole with limited time lag is important. In that sense CPI scores over WPI that is why 157 countries out of 181 countries use CPI for tracking inflation. India has the highest retail inflation among the BRICS group of emerging economies- Brazil, Russia, China, and South Africa. Unlike most central banks, the RBI mainly uses the WPI for monitoring inflation. Inflation is a long term phenomenon, a result of rapid economic growth, rising incomes of a youthful population, stagnating agricultural production and supply capacity falling sort of demand. Hence, it is imperatives to moderate inflationary pressures and absorb the price shocks before they hit the real economy. Monetary management and fiscal policies such as price controls and quantitative restrictions can only prove to be effective as short term solutions.
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Recommendations
Government should increase the production. Proper commercial paper Encourage saving. Proper investment policy. Our first and foremost concern is to keep the inflation rate under 7 percent cause with this inflation rate growth is positive. Our government should take initiative to reduce. Deterioration of budgetary balance because budget deficit is the major obstacle to growth trend. Our government should take steps to increase foreign exchange reserve which will add a lot to growth.
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BIBLIOGRAPHY
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APPENDIXES
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