INFLATION: Whether Good or Bad for Economy

Overview:

One of the biggest issues in front of the Indian economy is the rising inflation. The rising
Inflation came in the midst of the celebrations of the economic growth, which reduced
the charm of growth. This paper talks about the impact of Inflation on growth rate, the
measures taken by the government to curb Inflation and its impact on the economy and
the best-suited method that could be implemented keeping in mind the long-term
solutions and some advantages of inflation.

Introduction:

Inflation is nothing but a rise in the level of prices of goods and/or services in an
economy over a certain period of time. When the price level rises, each unit of currency
will buy fewer goods and services; consequently, leading to erosion in the purchasing
power of money – it is a loss of real value in internal medium of exchange and a unit of
account in the economy. The inflation rate is a chief measure of price inflation. It is the
annualized percentage change in the general price index (normally Consumer Price
Index) over time.

Inflation is usually a cause of uncertainty in the economy. Low inflation causes

uncertainty among the producers and high inflation eventually leads to uncertainty among
the consumers. It has been rightly said that for a developing country like India, some
inflation acts as the motivator for the producers to perform better, but at the same time
acts as the repellent for the customers. Hence for the substantial economic growth it
becomes mandatory to maintain the stable inflation rate, which ranges from 3.5-4.5%. It
was only during the period of economic crisis in India that India faced the problem of
very high inflation.

In the recent times one could witness the highs in the inflation rate. It is being
experienced when we are targeting the economic growth in the double digits. The high
inflation rate has no doubt reduced the speed of economic growth.

Meaning:

Inflation and Economic growth:

Inflation is nothing but the rise in the prices. It happens as a result of disequilibrium in
the demand and supply. The supply of money is relatively more, thus demand for goods
increases to a greater extend. But the problem arises when the supply of goods is unable
to match the rise in the demand for the goods. At this moment Inflation acts as a trap… it
is expected that due to the inflation, the investment plan will be postponed and ultimately
it is the production that would suffer. There is negative correlation between inflation and
economic growth. Inflation not only reduces the level of business investment, but also the
efficiency with which productive factors are put to use.

There are several factors affecting the GDP, though there should be efficient and
effective factors to reflect a robust and sustainable growth rate. The economy no doubt is
flourishing, but the rising trend in inflation and apprehensions relating to its control have
reduced the pace of the economic growth.

The graph showing the inflation and GDP trend over the past few years reflects that
although the adverse influence of inflation on growth looks small, but this is clear that the
long-term effects on standards of living are substantial.

It has been observed that every episode of high inflation is swiftly followed by a regime
of low economic growth. For example, inflation was as high as 13.7% in FY1992 while
the economic growth was 1.3% in the same year. Another such example was FY01 with
inflation at 7.2% and economic growth at 4.4%. FY88, FY80 and FY75 were other such
examples of high inflation dragging economic growth relative to their preceding years.

On the contrary, moderate or low inflation results in high economic growth. Recent era of
high economic growth from 2003-2008 was the best illustration of this negative
correlation between inflation and economic growth. The average inflation for the period
was moderated to 4-5 % during FY03-08 , while the economic growth was observed
above 8.5% for almost all years except FY05 when monsoon played spoilsport. In short,
the empirical evidence suggests that price stability is key for sustainable economic
growth.

Measures:

In the recent past, central government with RBI, is taking certain steps to curb inflation,
such as: raising rate of interest, increasing CRR etc… but neither proved effective. They
had their own repercussions….
 Raising rate of interest: The day RBI decided to hike interest rates…the reaction
could be seen on the sensex. It was in April 2007, that reaction of the rise in
interest rates was seen on the Sensitive index, posting its biggest drop in ten
months, closed deep in red with a 4.7 per cent intra day loss.

 Increasing CRR: On March 30, 2007, RBI announced the monetary measures to
control inflation. The step taken by them was to increase the CRR by 100 basis
points. As a result of the above increase in the CRR, an amount of Rs.15, 500
crores of resources of banks would be absorbed. This would make it difficult for
the banks to lend money. Ultimately the investments in several projects would
also be adversely affected.

It has been rightly stated by RBI governor that interest rates or CRR if increased further,
will not be beneficial for the developing economy. It was observed that whichever way
they moved, the final result will come in the form of the trade-off between inflation and
growth.

How Inflation is good for economy :

1. Business Growth

Controlled growth of Inflation, can become part of business growth, simply because
savings are often invested, because of the net loss if they are kept in a Bank.

During times of controlled Inflation, people in the past tended to spend, as they feared
prices could rise, saving on buying now, rather then paying more later.

2. Falling Debt Values

Higher Inflation eats away at the real value of a currency. This could mean that the actual
value of debts decrease, benefiting indebted businesses and private individuals.

3. Higher Stock Values

Stocks bought at an earlier value, could rise in price and sold off at a higher price
bringing higher profitability.
4. Rising asset Values

Values of fixed assets could rise, making some Companies more financially secure.
Traditionally higher Inflation often leads to higher prices, therefore fixed assets in theory
should rise in value.

Conclusion:
It is desired to understand the root cause of inflation. After analyzing various situations,
we can say that it is unsystematic economic growth has lead to inflation. This is because
the economic growth has lead to the rise in the levels of investment, production, and
employment and ultimately there was rise in the level of income. The purchasing power
of the customers has increased to the greater extent. They have money in their hands to
demand what they desire, but the market is not yet ready to supply them enough. This
difference in the demand for and supply of goods has caused inflation. Therefore, as one
can foresee, the suitable measure to control inflation gradually would be to increase the
supply of goods, so as to match the demand of the consumers and gradually increase the
value of money.
Hence for the substantial economic growth it becomes mandatory to maintain the stable
inflation rate, which ranges from 3.5-4.5%. But now a days it is spiraling beyond this
limit therefore corrective measure are required.

The past trend shows that with the time the inflation has kept on increasing at the cost of
the decline in the growth rate. At this point of time the government and the regulatory
bodies should understand that the situation is of NOW OR NEVER. It is desirable on
their end to take firm steps instead of following the technique of trial and error. Or else
the day is not far, when the dream to see India Shinning will be shattered.

To conclude it can be said, "The efforts to keep inflation under control will sooner or
later pay off in terms of better long-run performance and higher per capita income."