written by | April 18, 2022

Inflation and its Impact on the Economy

Inflation and deflation are two sides of the same coin. When there is a continuous increase in the prices of products, it is termed inflation. When the prices of products continue to fall consistently, it is termed deflation. Inflation reduces the buying capacity of consumers. The remuneration, whether employee salaries or labour wages, do not increase in the same ratio during inflation, causing great difficulty for everyone. However, the dearness allowance of salaried government personnel is increased to tackle such situations.

It is often the middle-class and the lower sections of the economy which are impacted immensely. In certain cases, the inflationary economy is welcomed because it enhances consumption, increasing the demand for goods and services. Some studies state that inflationary situations help boost production levels, especially when a large number of labour resources are idle. In a deflationary economy, prices spiral downwards, making buyers spend less. This results in a reduction in demand. A steep decline in sales prevents manufacturing and other production facilities from venturing into growth and expansion projects. The entire economy is impacted in a very serious manner.

Did you know?

After World War 2, Hungary experienced a doubling of prices at consistent intervals of 13.5 hours

What Are the Key Causes of Inflation?

There are various factors responsible for an inflationary situation. Some of these include:

Flourishing Economy

When a country’s economy is in an expansion mode, the purchasing power of consumers increases as they have more cash on their hands. Their increased demand for various goods or services results in a price rise. Increased demand also results in more job opportunities which in turn results in more money and increased spending power. This scenario in an economy is better known as demand-pull inflation, as it is directly linked to the growing demand for various products and services.

Also Read: Effect of GST on the Indian Economy

Cost-Push Inflation Scenario

In this type of inflation, the prices of various raw materials used in different goods' production and manufacturing processes increase. As a result, to retain their margin of profits, the manufacturing businesses increase the cost of their end products. Consumers are at the receiving end of such high prices.

National Debt Management

When a nation experiences increasing levels of debt, it resorts to two options:

  • It can create a cost-push situation by increasing taxes where the onus falls on the consumers.
  • Printing of additional money will result in a demand-pull inflation scenario.

Imposition of New Regulations by the Government

This involves the government applying new tariffs, making it difficult for companies to manufacture their products at earlier prices. They increase their production costs which are ultimately borne by the end-users. This is another example of a cost-push inflationary situation.

Changes in the Foreign Exchange Rates

Most countries accept the American currency (dollar) for their commerce transactions with everyone across the globe. Fluctuations in these rates impact the inflationary situation in such countries.

What are Some of the Effects of Inflation?

Inflation produces a distressing impact on consumers and the overall economy. Some of these include:

  • A reduction in the total value of your investments. This could be for your golden years of retirement
  • Reduction in the spending power of consumers
  • The decrease in demand makes organisations reduce their production and manufacturing
  • This results in the laying-off of labour forces
  • There is an increase in unemployment
  • Since production and manufacturing processes are severely impacted, domestic production ceases to be competitive. This impacts the currency, which gets devalued.
  • The economy experiences a complete slowdown in growth and development.
  • Despite the above facts, economists consider a 2-3% rate of inflation a healthy sign because it results in a direct wage increase and an increase in the revenues of organisations. This enhances the inflow of capital into the economy.

However, the current inflation rate in India 2022 is about 6.07%, which is not healthy for any economy.

How is Inflation Measured in India?

Inflation in India is measured on the premise of two key points. These include:

  • The Wholesale Price Index, which is popularly referred to as WPI
  • The Consumer Price Index is better known as CPI.

The ministry of commerce & industry in India calculates the wholesale price index. WPI is based on 697 products and is an indicator of the collective prices, measured on a wholesale basis. There are three different categories included in this:

  • Products that are manufactured
  • Key products that include food
  • Power as well as petroleum

However, when Mr Raghuram Rajan was the Governor of the Reserve Bank of India, he introduced a motion to the CBI. The Ministry of Statistics & Programme Implementation collects the cost prices of trial products and services every month. It takes into consideration if any changes in the prices have been implemented. 

Price indices are resorted to in India to understand the rate changes of goods and services. For example, a litre of milk costs ₹20 in 2021 and costs ₹22 in 2022. It is considered a 10% inflationary rate.

Also Read: 10 Things You Need to Know about the Union Budget 2022

Ways to Overcome Inflation

There are numerous ways for a country to implement corrective measures to combat an inflationary situation in the economy. Some of these include:

  • Reduction in expenditures of the government –  This will ease the deficit situation. The government can raise more revenues via taxation measures.
  • The supply of money should be limited. Such measures lead to reducing inflation.
  • Increase the income tax rates wherever possible – This will reduce the buyer’s purchasing power and reduce the levels of inflation.
  • Individuals can combat inflation by increasing their savings. This will help them plan for their retirement phase in a better manner.
  • Individuals must make practical investments in long-term schemes. This will help them combat future inflationary situations.

Conclusion

The details of this article would have informed you about the causes and adverse effects of an inflationary economy. The content informs you about the positive impact of inflation. Wholesalers resort to hoarding goods and services to later sell them at higher prices. The government can implement a monetary policy to prevent such situations.

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FAQs

Q: What is retail inflation meaning?

Ans:

When a change occurs in the consumer price index across a certain time frame, it is termed retail inflation.

Q: Which is one of the most effective tools to control inflation?

Ans:

A strong monetary policy of high-interest rates implemented by the central government reduces the supply of money. If the supply of money is regulated correctly, it will ease the levels of inflation.

Q: Does inflation affect the stock markets in a country?

Ans:

Yes, it does. In a high inflationary economy, value-based stocks are not impacted. They experience enhanced performance. A low-inflationary situation enables a healthy performance of growth-based stocks.

Q: Are commercial businesses impacted during inflation?

Ans:

Inflation brings about a reduction in your purchasing power. When you spend less, it means fewer sales for businesses, impacting their profits.

Q: What are the primary causes of inflation?

Ans:

One of the most common causes of inflation is the government’s decision to increase the rates of interest. This brings the economy to function at a slow pace. This results in lesser goods, high prices, and high levels of unemployment, leading to recession.

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