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Economics Class
 
Impact of Inflation
Positive impact:
  • Moderate level of inflation (at least 2 %) stimulates economic growth-
  • a. It increases profit margins of firms which encourages them to increase production and supply.
  • b. It indicates that there is no dearth of demand in the economy which improves profitability expectations/business environment which in turn stimulate capital formation.
  • Phillips Curve: Inflation Vs. Unemployment (downward slopping)
  • High Inflation is not desirable for long run, growth can not be sustained.
Negative Impact:
Social Impact
  • Deteriorates standard of living- real income decreases > capacity to save decreases > Savings decreases> Investment decreases. 
  • Regressive: Impact on poor relatively more - because marginal utility for them is relatively high. 
  • Increases inequalities - Profit of Firm increases, Real income of salaried class/servicemen (esp. unorganised sector)
 
Economic Impact
  • High Inflation induces the GoI/central bank to adopt contractionary fiscal and monetary policies that retards economic growth/capital formation.
  • Distorts resource allocation - It diverts profit towards high profitable areas . It enables even inefficient firms to make profit and waste resources, affects economy efficiency and productivity.
  • Real interest rate decreases > willingness to save decreases. Note  Real interest rate = Nominal interest rate - inflation rate. (Debtor will gain if Inflation >= Nominal interest rate, Depositor and Creditor lose). Financial Investment (E.g - FD , PF , Bonds) will reduce > Investment reduce , Physical Investment (e.g Land , Gold ^ > Import  ^ (rupee depreciate) > Trade Deficit ^ ) ^
Impact of Crude Oil Prices 
 
  • If prices will come down - Inflation will reduce > RR  reduce (Interest rates reduce and Investment ^ )>AD ^ >Economic Growth 
  • Budget: Subsidies on Petroleum decrease,  Tax ^  > Budgetary Deficits decreases.
  • External Sector : Import Value reduces > Trade Deficit reduces  > CAD reduced > Outflow of Forex reduced > Rupee depreciation Checked  > Balance of Payment/BoP ^
  • Overall Impact > Expansionary Monetary Policy > Credit rating  ^ >   Foreign Investment ^
 
The demand for Gold and Steps taken by Government
 
Inflation-indexed bonds 
 
  • Ensure a fixed rate of real interest.
  • Interest rate = 1.5% + Inflation rate 
  • Impact > Financial Investment ^ > Demand of Gold ^ > Import reduces 
 
Sovereign Gold Bonds, 2015
 
Gold Monetization Scheme, 2015
 
Impact of Inflation continued
 
  • The real interest rate will reduce 
  • Deteriorates Balance of Payment situation of the country. Widens trade deficit. 
  • The high rate of Inflation retards economic growth compelling govt. to adopt contractionary fiscal and monetary policies
  • Illicit activities - Hoarding and Speculation by Firms.
  • Distorts resource allocation
 
Disinflation
 
  • Meaning & Definition- Rate of inflation reduces  (price level decrease without any adverse impact on NI , output , Employment etc) 
  • Example- 10% >9%>8%
 
Deflation/Negative inflation
 
  • Meaning & Definition - Persistent decrease in price level i.e negative inflation 
  • Impacts on production - Reduction in NI output 
 
Reflation
 
  • Meaning & Definition  - Increase in price level during eco recovery
 
Inflationary & Deflationary Gap
 
  • Meaning & Definition 
  • Examples
 
Overheating of Economy
 
  • Meaning & Definition  -, It is a situation in which further increase in aggregate demand during boom phase fails to increase real output leading to inflation. ( During Boom , AD ^ , price ^ )
 
Inflationary  Gap
 
  • Meaning & Definition - It is a situation in which AD is more than productive capacity of economy. 
  • Examples - AD (120 cr) > AS full employment 100 cr
  • Impacts on the economy - It leads to inflation 
 
Deflationary Gap
 
  • Meaning & Definition - It is a situation in which AD is less than productive capacity of economy. 
  • Examples - AD (70 cr) < AS full employment 100 cr.
  • Output reduces >Price decreases   
  • It leads to deflation and recession.
 
Suppressed/ Repressed Inflation
 
  • Meaning & Definition - It is a situation in which AD is more than AS but government prevents price level from rising through direct price control measures (price regulation, ceiling price, etc).
  • Government can not suppress inflation as supply chains are in unorganised sector.
 
Open Inflation
 
  • Meaning & Definition - It is a situation in which price level increases without any price suppressive measure by the government. Persistent increase in price level.
 
Stagflation
 
  • Meaning & Definition - It is a situation in which high inflation is accompanied with recession (unemployment). It is caused due to cost push inflation (reduction in aggregate supply)
  • Happened in India and the world in 1973
 
Misery Index
 
  • Meaning & Definition - It is a summation of inflation rate and unemployment rate.
 
Philips Curve
  • Meaning & Definition - Inflation is indirectly proportional to Unemployment.
  • Relation with stagflation, Misery Index - Stagnation ^> Misery Index ^ . Phillips Curve is a  different concept, no correlation with stagflation and misery index. 
 
Structured and Bottleneck Inflation 
  • Meaning & Definition - It is caused due to structural deficiencies of an economy. E.g - Scarcity of Capital, infrastructural bottlenecks, market imperfection etc. 
Core Inflation and Headline Inflation
  • Meaning & Definition - It is based on the prices of only those commodities whose prices are non-volatile. That is it does not take into account prices of food and fuel. It shows a partial picture, not comprehensive, it is used to show trend or tendency of Inflation. If core olfaction is low it reflects that inflation is not going to persist and headline inflation is temporary in nature .
  • It is based on the prices of all types/groups of commodities. 
  • Difference between the two- Core Inflation will fluctuate less as compared to Headline inflation.